Keeping Track of Mutual Fund Expenses

The first step is to understand mutual fund expenses. The next step is to avoid them!

Mutual funds are designed for people who want to minimize risk and volatility in their investments, maximize purchasing power by pooling their resources with others, and minimize the costs inherent in buying and selling stocks. But you might be surprised that not all mutual funds have low expense ratios: many of them charge you what we feel are excessive fees. The common sense investor needs to be aware of the fees and expenses involved in any mutual fund investment.

It turns out that mutual funds that are actively traded can have surprisingly high expenses. This is reflected in their turnover costs. Actively traded mutual funds have an active manager who pays attention to the markets and will buy and sell stocks based on performance. This sounds like a great idea (we all like to know that our money managers are working for us), but actually results in increased costs.

Note: not all actively managed mutual funds have high turnover costs. Some fund managers believe in buying for the long-term and these will, subsequently, lower turnover costs.


Turnover is a measure of the volume of buying and selling that’s gone on in the mutual fund management. High turnover is something you should pay attention to in mutual funds. Make sure you always get turnover figures when you’re looking at prospective mutual funds. You’ll always see a difference in turnover between actively managed mutual funds and index-based mutual funds. For a benchmark, index funds often have fees of around .2% per year; managed funds are more likely to fall around 1.5%, a 1.3% difference. Add in the taxes, and you can see that a managed fund needs to perform significantly better to buffer the additional expense.

Low turnover in a managed fund is indicative of a long-term investment philosophy. At The Common Sense Investor, we think that the best investment philosophy is the one that sticks to the fundamentals of long-term investing. By looking for strong long-term performance but low-turnover, you can identify actively managed mutual funds that outpeform index funds. As always, stay away from funds that seem to be treating the art of investing like a game. High turn-over can be indicative of poor discipline and poor long-term vision.

Watch for this: the turnover value is sometimes divided in half because one security is sold and one bought in the same transaction. The standard measure requires both to be counted as one each. If your actively managed funds appears to have suspiciously low turnover, ask about this. Look at your management fees, too; they can be from .5% to 2.5%.

Managers who depend on commissions to make their profits are more likely to engage in high turnover management. This is usually a conflict of interests. If you find your mutual fund does this, run the other direction and get out as soon as possible!

Taxes, Taxes, Taxes

In addition to resulting in higher fees and commissions to managers, high turnover also results in higher taxes for the fund, which of course are passed on to the investor. Capital gains tax from selling an investment turns into taxable income when distributed to investors.


In today’s market, load funds should almost always be shunned and avoided.

Front-end loads are commissions a mutual fund pays to a broker when shares are purchased. Really, you should avoid loads altogether, but if you’re attracted to a load fund, watch out to be certain these aren’t too high. If you don’t pay any up-front fees, ask about how high the back-end load is; you’ll pay for it when shares are ultimately redeemed. A few funds, though, use a level-load fund, which only charges you a back-end load if shares are sold within a year. Watch out for loads; they’ve been known to be as high as 8.5%!

There are also mutual funds with no sales charges called no-load funds, and these are generally sold directly from mutual fund companies or by discount brokers for a flat transaction fee or no fee (if it’s a no-fee, it’s likely that the fund paid the broker’s commission, so check these out especially carefully.) Vanguard, T.Rowe Price and Fidelity are good no-load index fund companies.

Management and Maintenance Fees

If you have an actively managed fund, then chances are there are several employees whose full time job is to support the fund’s existence. They’ve got to be paid somehow. Normally, their salaries are usually drawn directly from the fund either as a percentage of total assets or as a percentage of total performance. Similarly, someone has to pay for office space for these employees and for other costs such as media exposure, investor relations, trading fees etc. These expenses are usually not taken from the individual investor, but get extracted from the overall fund.

Index Funds

If minimizing fees and expenses is your goal, than index funds are the way to go!

Index funds are mutual funds that, rather than being actively managed, are tied to a specific index, like the Dow Jones or S&P 500. These mutual funds have significantly lower expenses, but are not likely to perform quite as well. Index funds are more likely to be very general and diversified, and are good for long-term investors looking to minimize costs and volatility. The shortcoming of index funds is that they tend to not be selective between good and bad companies, and rather come close to investing blindly in a wide array of companies, some of which are good and some of which are bad.

While it is true that actively managed funds, averaged out, have historically not returned as much as index funds, we believe that you can beat the return of index funds by honing in on a no-load, low-expense, extremely well managed fund that has historically beaten the indexes by several percentage points.

Pitfalls of Mutual Funds

The pitfalls of mutual funds

Just like any other form of investment, mutual funds also offer their balance of advantages and pitfalls. The common sense investor should always be aware of the potential downside to any investment medium. If you have plans of investing in mutual funds, keep these pieces of advice (and pitfalls to avoid) in mind.

There is real danger of overdiversification

Diversification is a good attitude when it comes to successful investing but there is a danger when mutual fund investors go overboard and overdiversify. Diversification aims to reduce the inherent risks that are associated with holding a single security or type of fund. Overdiversification involves two things. First, it occurs when an investor gets many funds that significantly overlap each other’s holdings thereby not really receiving the benefits of risk reduction given by diversification. Second, overdiversifcation can result in a drag on your overall return. By having too many poor-to-mediocre funds, the investor loses out on the return potential of a few well-managed funds.

It should also be pointed out that buying mutual funds does not automatically mean that you have diversified your investments. If you have funds that concentrate only in a particular market sector or region then you are still relatively at the same amount of risk.

The danger of blind diversification

One of the most pervasive errors in the investment industry is the view that you absolute must diversify across industries and asset classes. Many mutual fund managers buy into this philosophy. In fact, the whole phenomena of Index Fund investing is a reflection of this view.

At The Common Sense Investor we think this philosophy results in watered down returns and unintelligent investment practices. Your mutual fund should employ a strong investment philosophy that takes advantage of the fact that good companies will, more often than not, use your money wisely. But if you’re not seeking out good companies with your investment money, then who knows how your money’s being used.

The danger of passive investing

When you invest your money in a mutual fund, you are entrusting your money to a particular investment philosophy (either a manager, an index, an asset class, etc.) However, there is a danger that in entrusting your money to someone else, there is also a corresponding tendency to put blind faith in their ability to perform. The common sense investor needs to actively monitor the performance his funds and the investment philosophy that they employ.

Mutual funds give fluctuating returns

Mutual funds are like other investment options in that they do not offer a guaranteed return. There is also the slim possibility that the value of the mutual fund you bought will depreciate. Mutual funds also experience price fluctuations along with the stocks that make up the fund, not like bonds and treasury bills, which are more or less fixed-income products. The good news is that there are proven and consistent methods for using mutual funds to outperform the return of bonds and cash investments. But it is essential to research the fund you will be investing in. Just because a fund manager will be overseeing the fund it does not mean that it will be a strong performer. Rather, the long-term returns from a fund are a direct result of the fund’s investment philosophy: so choose a good one

Always remember that mutual funds are not guaranteed by the US government. This means that in the case of dissolution, you will not get anything back. This against reinforces the need for investors to do their homework and pick a consistently strong, well-managed fund with a long track record of superb earnings.

Money sitting around and not working for you?

Mutual funds, as you well know, accumulate and pool money from thousands of investors. This means that everyday investors are putting in and withdrawing money from the fund. In order to maintain this practice they have to keep a large portion of the money as cash. But having that amount of money is lying around, although great for liquidity, is not that good considering that this money could be used to work for the mutual fund and thus ultimately more advantageous for everyone. Look for funds with low turn-over and a low proportion of cash to stock.

Mutual funds can be costly

Mutual funds already provide investors with professional management. But this comes at a cost. Funds, in order to maintain its service, will have to charge different fees that would ultimately reduce the overall payout to investors. What’s more, the fees are charged to investors regardless of the performance of the funds – so in times where the fund is underperforming, the fees might only further magnify the monetary loss.


Having reviewed the various disadvantages to and potential pitfalls of mutual funds, we believe that mutual funds can and should be an essential component of the common sense investor’s overall investment plan. The key point throughout is that you have to take an active approach to mutual fund investing: only choose funds that have consistently strong long-term performance with a solid investment philosophy. And never forget to actively monitor each fund’s performance at least once a year.

Benefits of Mutual Funds

The Benefits of Mutual Funds

Ever since they were formed, mutual funds have been a favorite investment choice for the average investor. Mutual funds are simple, cost-effective and they offer a level of diversification that one simply does not get in an individual stock. With mutual funds, you entrust your money with a good financial professional who should in turn use an intelligent investment strategy to pick stocks of good companies at reasonable prices. Below, we go into detail about some of the primary benefits of mutual funds and how they fit into the common sense investor’s strategy for building wealth.

Be warned: not all mutual funds are created equal. The common sense investor needs to seek out those mutual funds that are run by established managers with consistent track records and solid investment strategies.

Getting mutual funds gives you professional management

Buying mutual funds also means choosing a professional money manager who will use the money you have invested to buy and sell stocks. So rather than you doing the research for making investments a mutual fund’s money manager will do it in your behalf. This doesn’t get you completely off the hook, though! You still need to do research on the professional money manager and mutual fund that you pick. Don’t get stuck with a mutual fund dud. Make sure that the mutual fund expenses are low, that the money manager has a proven, consistent track record (don’t fall for a one year anomaly that artificially inflates his performance), and a sound investment philosophy.

Mutual funds offer asset diversification

There is one rule that investors of all persuasions have taken to heart is selective asset diversification. This simply means mixing the investments in a portfolio as a way of managing risk. There is much higher risk that one company will do poorly, then there is that 20-30 well-chosen companies will do poorly. Keep in mind that diversification is worthless if you diversify into a lot of bad investments. Still, there are some basic principles of diversification to keep in mind. As already mentioned, you can diversify into different companies, but you can also diversify into different economic sectors (e.g. technology, manufacturing, industrial, energy, etc.) and asset classes (e.g. large company, small company, foreign company, etc.). Regardless, always choose well-run companies at reasonable prices.

To illustrate this point, an investor decides to buy stocks in the manufacturing sector but also offsets that exposure by buying stocks from the industrial sector as a way of reducing the actual impact of the investment. In other words, if the stocks bought in the manufacturing sector depreciated, your other stocks would generally remain unaffected – independent of the movements in the previous sector’s market. To truly achieve the benefits of a diversified portfolio, you must buy stocks with different capitalizations in different industries. The Common Sense Investor does not recommend diversifying into bonds or cash because 1) they simply do not meet the objective of reaching your highest possible return and 2) companies work for their shareholders, not their bondholders.

Doing the research and developing a strategy for diversification can be tedious, time consuming and definitely costly.

But with mutual funds, the diversification is more or less built in. You get the instant diversification and asset allocation but without having to shell out a big amount of cash. Just make sure that you pick good mutual funds. There are a lot of duds out there.

Mutual funds offer good economies of scale

When investing in mutual funds you can take advantage of their buying and selling size – and this can reduce the transaction costs to your benefit. Buying mutual funds allows you to diversify without having to pay a lot of commission charges.

Mutual funds are offered at lower denominations

Investors usually don’t have the exact amount of money to buy round lots of securities. A round lot of stocks would usually fetch for a high price. But it is easier to purchase mutual funds because it is usually offered in smaller denominations. This means investors with limited funds don’t need to wait to save up to afford getting into an investment opportunity.

Mutual funds are liquid

Another advantage of mutual funds is that you can get in or out of this investment relatively easily. You can sell mutual funds at any time without any penalty because they are liquid like regular stocks. The price of mutual funds is determined at the end of any trading day based on the value of its holdings. The price of any sale is determined by next market close and you can expect to receive your funds within 48 hours by EFT.

Mutual funds make systematic investing easy

Most mutual funds will allow you to set up what is called an Automated Asset Builder to regularly take a set amount of money out of your bank account and invest it in the fund. This makes investing automatic and systematic, a necessity for the common sense investor. It also enables you to take advantage of a natural investing strategy called dollar cost averaging.

In summary, the benefits of mutual funds are many and they make a lot of sense as an investment vehicle for individuals who don’t have the time or money to be active investors. They provide opportunities for instant diversification, strong money management, low-minimum purchases, easy systematic investing and the virtual liquidity of an online checking account. By doing your research once to find a trustworthy and proven money manager, you can reap the rewards of rational investing without doing all of the work yourself.

Picking Good Mutual Funds

A Simple Method for Picking A Good Mutual Fund

Not all mutual funds are created equal. Some are indeed great investments. But many mutual funds are poor investment choices for one basic reason: they fail to employ a solid investment philosophy.

It is not uncommon to find mutual funds that are called “index funds.” Index funds basically employ a blind investment strategy: they buy a little bit of every company in a stock index. Now, some financial managers see this as a good investment strategy because it gives you instant diversification. The problem is that index funds are not selective enough in their diversification: they spread your money between good companies and bad companies, as well as expensive companies and cheap companies. In our uncommon opinion, index funds are not rational choices for maximizing your investment return.

Mutual fund investing has many benefits, and perhaps the best one is that the majority of your research comes in the form of identify a good mutual fund manager who you can trust with your investments. Once you’ve done the work upfront, you can enjoy consistent returns that beat the markets.

So how do you find a good Mutual Fund?

Follow these 8 rules and you’re sure to find a good fund with a trustworthy manager.

Rule 1: Only invest in a mutual fund that has been around for at least 10 years

Rule 2: Avoid funds with high-expenses (above 1.35%) and only go with no-load funds (funds that don’t charge to purchase or sell shares)

Rule 3: Only invest in a mutual fund that has a 10-year, 5-year and 3-year return that beats the S&P 500 (aim for at least 12%)

Rule 4: Never invest in a mutual fund that has lost money in any three-year period and avoid funds that lose money two years in a row.

Rule 5: Look for consistency: choose three different three year periods of time and see if the fund has consistent returns over each of those periods above your goal (e.g. 12%).

Rule 6: Look for consistency II: Do the three-year, five-year and ten-year average annual returns and make sure they all fall above your goal (e.g. 12%)?

Rule 7: Look for consistency III: Make sure that the mutual fund does not rely on luck. In other words, don’t pick a mutual fund that had abnormally good returns in one year. Such a year might artificially make the fund look good, when in fact the manager just got lucky.

Rule 8: Never invest in a fund that seems to employ a blind or random investment philosophy. In other words, don’t invest in a mutual fund whose manager neglects to discriminate between good and bad companies, but instead invests your money with, for example, all the major “energy” companies. This is a recipe for disaster.

Using these methods, we’ve identified these three excellent mutual fund choices (as of November 2005):

FPA Perennial Fund (FPPFX)

Three year 18.53 +5.5% on the S&P

Five year 16.96 +5.5% on the S&P

Ten year 15.89 +6.6% on the S&P

2002-2004 14.52% Average annual return

1999-2001 19.40% Average annual return

1996-1998 16.50% Average annual return

Investment Strategy: “The managers believe that owning high return-on-equity companies over the long term produces high shareholder returns and that a patient investor can take advantage of price opportunities or market inefficiencies to periodically acquire the securities of such companies at attractive prices.”


Three year 15.95 +3% on the S&P

Five year 13.65 +2.5% on the S&P

Ten year 14.84 +5.5% on the S&P

2002-2004 14.94% Average annual return

1999-2001 12.41% Average annual return

1996-1998 23.28% Average annual return

Investment Strategy: “We believe successful long-term investing results from disciplined research, not from impulsive speculation or arbitrary guesswork. Since 1983, we have pursued an investment agenda that emphasizes small and medium-sized companies whose share prices are undervalued.”

Muhlenkamp (MUHLX)

Three year 22.77 +10% on the S&P

Five year 14.48 +3.5% on the S&P

Ten year 15.83 +6.5% on the S&P

2002-2004 17.5% Average annual return

1999-2001 15.35% Average annual return

1996-1998 21.7% Average annual return

Investment Strategy: “Invest in the common stock of highly profitable companies, as measured by Return on Equity (ROE), that sell at value prices, as measured by Price to Earnings ratios (P/E).”

Bonus: Low P/E 12.9

Choosing Your Retirement Home

Picking a Home For Retirement

There are houses for every stage of life, from your first starter home to the home for your growing family, to the home you’re looking for now. When you’re ready to retire, it is critical that you have a home that makes you happy – you’re going to be spending a lot of time there.

Your new home is your reward for a life well-lived so far. This should not be a home that looks backward, but rather one that looks forward to the things you want to do with your retirement. Below are a few things to think about when you’re ready to buy this house.

Less space means less maintenance, housework, and yard work. You just retired – you don’t want to work more at home! And without children living at home, you really don’t need as much space. You may choose to buy a large house anyway, but you should really think about keeping it small.

Choose a home with a single floor. Even if you’re doing well with your health right now, bones grow more fragile with age, and peculiar things happen to your sense of balance. Minimize the chance of accidents by buying a ranch home on one level., with storage on ground level instead of a basement. If you must have stairs, make certain the banisters are at a good height for you, and are very stable.

Pay attention to outdoor living space as well as indoor living space. You’ll find that you live outside more after retiring than you did before. Think about your deck and your garden. If you’ve always wanted a hot tub, this is the time to get one. Same for swimming pools. As above, though, keep it on one level; that includes step-ups and multilevel decks. They look nice, but it’s just not worth the risk.

Leave room for pets, even if you don’t have one. Even if you hate dogs and cats. When you’re lonely, sometimes a pet can make the difference. But if you don’t have a place for one, you won’t have the choice.

Make sure you have at least one guest room for the children and grandchildren. Your family grows increasingly important when you have time on your hands. Take away at least one excuse they may have for not visiting by having a guest room available for them whenever they decide to come by. If you have two guest rooms, put bunk beds in one. And think about the future; you may not have grandchildren now, but in five years, who knows?

Make room for your hobby or your post-retirement career. Your retirement years are the perfect time to write that novel, start that woodworking business, or even build additions to your home. Make sure you buy a home that provides an appropriate work space for your new dreams and goals. These are the things that make you alive. And by the way, your office should not be your guest room. When you have a room used for multiple purposes, it’s very easy to forget one of those purposes.

Live near hospitals, doctors offices, and friendly neighbors. Again, even if your health is good right now, you don’t want to take any chances. If anything does happen, you want someone who cares about you finding you quickly, and then you want fast transportation to medical help. Your chances for doing well after a stroke or heart attack go down significantly with every minute you’re delayed in getting to a hospital.

Live away from traffic and pedestrian-unfriendly streets. You don’t want to deal with that any more! Give yourself the space you need to relax and enjoy your new, second life. If you get away from the stress, you’ll enjoy your retirement much more.

Dollar Cost Averaging (DCA)

What is Dollar Cost Averaging?

Dollar cost averaging is a method of investing that the common sense investor can employ for buffering against some of the unknown factors involved with stock investing while taking advantage of natural stock market volatility. It also encourages systematic investing, which is an essential factor in the acquisition of wealth.

The ideal goal for stock investing is to buy low and sell high. But stock market highs and lows are unpredictable. Dollar cost averaging provides a systematic way to naturally buy more stock when the price is low and less stock when the price is high, and it saves you from having to “time the market.” Similarly, it protects you from short-term, irrational market movement and benefits from the fact that the markets have a much more consistent track record over long periods of time.

Simply put, dollar cost averaging is a technique used to reduce an investor’s market risk by means of the systematic purchase of securities at predetermined intervals and set amounts. Actually, DCA is a method that is used by many investors without them even realizing it.

With Dollar Cost Averaging, an investor works into a good investing position, not by investing assets in a lump sum, but by slowly buying small amounts over a longer duration of time. By doing this, the investor gets to spread out the cost of investment over several years thus giving a form of insulation against major fluctuations and changes in the market price.

Dollar Cost Averaging, or DCA, is an effective investing technique and requires very little work. The markets, despite having bad days or even years, still have a tendency to go up (or appreciate) over time. By investing a predetermined amount of your money every month you get to buy fewer shares when the market is high and more shares when the market is bearish. As an example, with DCA your investment may buy you five shares in a sluggish market and 10 shares in strong market. This lessens the risk of having to invest a large amount in a single investment during the wrong time. In a falling market the average cost per share is much smaller. This, in effect, will help you gain better overall profits as the market rises over time.

There are people who may say that instead of DCA, it would be better to buy a lot when the market is at its lowest and then sell when it is at its highest. Ideally, of course, this is a good tactic, but then an investor must be able to predict when the market is at its lowest and at its highest to be able to profit from this tactic, which is extremely hard if not impossible. If anyone could do it, he or she would be rich.

For those who are interested in making a dollar cost averaging plan, three things must be considered first:

* You have to decide exactly the amount of money you want to invest every month. You have to make certain that you are financially capable of keeping the amount consistent. Failure to do so may make your dollar cost averaging plan ineffective.
* >You should select an investment that you would want to hold on to for the long term – preferably you should hold on to your investments for five to ten years, or even longer.
* At regular time intervals – it could be weekly, monthly, quarterly or a schedule that works best for you – invest the money in an equity that you have picked out. If your broker offers it, try to setup an automatic withdrawal plan so that the process becomes automated.

As always, when you dollar cost average, do so wisely. Choose good investments (good companies at reasonable/cheap prices) and do not invest blindly.

Dollar Cost Averaging With Your 401K

Your 401K plan offers a natural way to dollar cost average

Dollar cost averaging has been proven to be a good investment strategy for a variety of reasons: 1) you are not overexposing your investment to the risks involved in timing the market 2) you consistently invest your money on a regular, periodic basis.

Consistent investment is one of the keys to becoming a successful investor. Following a dollar cost averaging strategy ensures that you are maximising returns to your investment without unduly taking chances that might affect it negatively and also protecting your hard-earned investment from the fluctuations in the market. In fact, dollar cost averaging takes advantage of market volatility so that you buy more stock when the price is low and less stock when the price is high.

This prudent approach to investing (by slowly buying small amounts of stock or bonds over a longer period of time and at a set rate) is automatically set in motion by participating in a 401K plan.

A 401K plan allows the employee to systematically put away a portion of her paycheck, tax-free, for retirement investment. Contributions keep pace with the employee paycheck schedule, and thus spread the investment purchases over time and keep them consistent. Your employer’s 401k plan defines the maximum contributions that the employee can make as well as any matching contributions from the employer. The terminating employee then receives the proceeds either in a current or deferred lump sum or annuity. Penalties are payed if the money is taken out before a certain age since the 401k program was instantiated to spur retirement savings.

Employee contributions to their 401K plan are automatically deducted from their paycheck each period. The money is taken out even before the employee’s paycheck is taxed as an incentive for retirment investing. The contributions are then invested at the employee’s direction into one or more funds or stocks that are provided in the plan. Employers can match the employee contributions but they are not required to do so.

Given the way 401k plans work, by taking money out of paychecks, they naturally employ a dollar cost averaging strategy, inheriting all of its benefits such as protection against volatility and taking advantages of market swings. Making a commitment to invest is already taken care of because the deductions are automatically made for you. There is little room for temptation or to funnel the money into other things (you should never borrow against your 401k). Since the contribution is invested into a fund or funds of the employee’s choosing, she can determine which investment options are better for the type of exposure that she wants to commit for her plan. Thirdly, if the employee works in a company wherein it is policy for the employer to match the employee’s contribution, not participating in the 401k is like giving away money, and no one wants to do that. Company contribution allows the employee to know that by committing a certain amount every month to her 401k, she’ll instantly be rewarded by getting something very much like an extra bonus from the company.

In sum, by invesitng in your 401k or other retirement plan, you can receive all the benefits of an intelligent investment method that takes very little work on your part: Dollar Cost Averaging.

Prioritizing Your Retirement Investments – What Comes First, What Comes Last?

Choosing where to put your retirement money can be confusing.

Everyone knows that they’re supposed to invest for retirement. Some actually do and some don’t. But a common question that both current and prospective investors ask is: if I have a limited amount to contribute to my retirement, where should I put my money first, second and so on?

This is a guide to help you answer that question and figure out the best place to put your money for retirement investments. The answer is not the same for everyone.

In a best-case scenario, you’d max out your legally allowed retirement contributions each year. But many of us are not in a best-case scenario. We need to prioritize and place our money where it will be most effective. Here are some rules to guide in prioritizing your retirement investments. They are followed by a step by step decision making process:

Retirement Rule #1: Maximize Your Employer’s Matching Contribution

If your employer provides matching contributions in a company sponsored plan, then put in as much as you need to receive the FULL match. Don’t invest or save a dollar anywhere else until you’ve taken advantage of this immediate return. It’s not everyday that you can get 25-100% of a return on your investment in the matter of a day. That’s effectively what’s happening here.

Rule #1 was the easy part. But if your company doesn’t match, or you’ve got some left over money to invest, how do you choose between the other options?

Retirement Rule #2: Prefer Quality and Flexibility

If your employer’s retirement plan is very restrictive and doesn’t offer you very many good investment options, then opt to first max-out your self-selected IRA. Choosing a good IRA is as easy as choosing a good mutual fund: you want to identify a fund that has a strong track record, low-fees, good management and is poised to provide consistently high, long-term returns.

On the other hand, if you’re company’s plan does offer a wide array of good investments, it may also offer some “flexibility perks” that an IRA cannot offer. Many employer sponsored plans allow you to have non-penalized access to your funds via self-given loans that you might want access to in emergencies. While we strongly advise against touching your retirement funds, at least the money is available. On the other hand, if you can’t resist the temptation of using your retirement funds for non-emergency expenses, it may be advisable to stay with the IRA!

Retirement Rule #3: Roth or Traditional IRA?

In 2006, each individual can contribute $4000 to an IRA account. Individuals over the age of 50 can contribute $5000. But there are two IRA options: Traditional and Roth. Which should you pick? As a general rule, choose Roth if you plan to be in a higher tax bracket when you retire and choose Traditional if you think you’ll be in a lower tax bracket when you retire. The reason: you minimize the taxes you have to pay.

Questions to help you make your decision

1. Do you have enough money to maximize all your retirement options?

  • If yes, then do it! Just make sure to make wise investment decisions
  • If not, then proceed to question 2

2. Does your employer offer matching contributions?

  • If yes, then make sure you receive every bit of this match. Stretch yourself if needs be. But always make sure that you select a good investment from the options that are avaible.
  • If not, then things get a bit more subjective. Move to question 3.

3. Is your employer plan overly restrictive, offering only poor investment choices?

  • If yes, then opt for an IRA choosing the one that minimizes your tax payments
  • If not, then move to question 4

4. Choose the investment vehicle that offers the best long-term management of your money.

How Much Do You Need for Retirement

With baby boomers hitting 60, the question on everyone’s minds these days is how much you’ll need for retirement. The answer isn’t the same for everyone.

We work practically all our lives in order to provide for our families. We have to contend with so many expenses – our mortgage, our children’s education, medical expenses, food expenses, etc. You work in order to earn money to address all of those expenses. But you also work in order to prepare a nest egg for your eventual retirement.

The prospect of retirement brings with it mixed emotions. One is the relief that finally, you can just relax and enjoy and be able to pursue your other passions and hobbies and spend more time with your family. But then there is also the fear that the nest egg that you have prepared for yourself will not be enough to last your retirement years.

How much does one need for retirement. The answer depends on what your expectations are for retirement. Are you looking forward to a life of relative relaxation like painting, gardening or taking care of your grandchildren? Or are you planning on a retirement that is filled with activities like travelling overseas, frequent dinners in expensive restaurants and other social activities? Or perhaps you plan to do a little of both? Maybe you even plan to continue working part-time (this makes a huge difference). First try to envision how you want to spend your retirement and from there estimate the amount of money that is needed to fund those endeavors. This is a good way of finding out how much you will need to retire.

As part of the estimations that you will make in order to find out how much money you will need for retirement, you must also consider the expenses that you expect will increase when your retirement comes. Among these expenses are your health insurance premiums, medicines and travel expenses. Some of these increased expenses may be cancelled out by expenses that are most likely to decrease like work-related costs (transportation, food, clothes), educational fees and entertainment expenses. It is also possible that by the time you retire, you’ll have paid off your mortgage; one of the biggest monthly expenses.

Another important thing that you should do is to make an educated guess with regards to how much money you will accumulate over time (the growth of your projected earnings) as well as the inflation rate. You will be retired for many years and should continue to aim to maximize your overall wealth during these years. Even in retirement, we recommend aiming at 10-12% growth via solid mutual funds. Don’t settle for anything less, especially the bad, but common advice of putting your money in cash or bonds for security. The only money that should be in cash or bonds at any time of your life is that money that you’ll need within three years.

Although the inflation rate has been relatively low for the last few years, you should keep a steady eye on this metric as it determines the overall purchasing power of your money.

You should also be able to prepare for certain situations that are usually overlooked when preparing for your retirement plan but could have a tremendous impact on your savings. These situations include a temporary loss of income, illnesses, or the cost of caring for your elderly parents.

If you are planning on retiring at an early age then you must take extra attention on your money-making endeavors. It is a good idea to keep a good mix of taxable and tax-deferred investment options that can appropriately fund the early years of your retirement.

Questions to Consider When Calculating Retirement Needs

1. Do you expect to spend more or less in retirement than you do now?

If you have plans for traveling a lot, expect to spend more than you do now. If you mainly expect to relax in the comfort of your own home, expect to spend less.

2. Do you expect to work?

If you plan to work part-time in retirement, then you don’t have to save nearly as much money in preparation. By working as long as possible, you delay having to cut into your nest egg

3. Are you willing to invest, even in retirement?

For better or worse, many financial planners have convinced their clients that investing during retirement is too risky. Quite simply: they are wrong. What’s actually risky is not investing the money you don’t plan to need for at least three years. Especially in retirement, you should continue to let your money work for you. It works by investing it and aiming to make 10-12% interest per year.

4. Have you paid for your house?

If you own your house outright with no more debt, then you are in a unique situation. Throughout most people’s lives, they spend close to 1/4 of their money on mortgage or rent. By owning your house outright, you are eliminating a major monthly expense and significantly reducing the amount of money that you’ll need in retirement.

Doing the Calculations

After asking yourself the previous questions, try to come up with a rough estimate of how much money you’ll need in retirement on a monthly basis. You should err on the side of caution, by assuming that you’ll need more than you probably will.

Let’s say that you’ll need $5000/month. There are a number of ways that you could come up with that $5000. The easiest way, of course, is to continue working part time. Let’s say you make $1000 per month by working 20 hours per week. Ok, so now we need to come up with $4000.

As a general rule in planning, expect to make about 8% on your retirement investments. Again, this is conservative, and as I mentioned, you should be aiming at 10-12%. But, if you have $300,000 saved @ 8% annual interest, you’re looking at $2000 per month. Get that $300,000 up to $500,000 and you’re looking at $3333 per month. That would put your very close to your goal.

But let’s say that you’re only making $2000 from your investments. What other resources are there? This is where things start to get tricky. You could decide that you’re going to trust the government to provide Social Security. Depending on your historical salary, its not unusual to make $2000-$5000 per month this way. The younger you are, the less you should plan around Social Security.

If Social Security doesn’t get you to where you need to be, you could consider other options like a reverse mortgage on your home, or increasing the amount of time that you work each week. Of course, it may even come down to intentionally cutting back on your spending.

One way or another, there are a number of ways to meet a variety of retirement needs. The key is to be aware of what options you have for 1) making money in retirement and 2) reducing expenses.

Types of Retirement Plans

No matter what your job, there should be a retirement plan available to you.

The United States Federal Government has instituted a number of systems to encourage retirement savings among its citizens. As life expectancy increases, the need for individuals to save for retirement is stronger than ever. In addition to the natural returns on investment that you will get from investing in good companies, retirement plans give added benefits such as tax exemption and sometimes even company matches.

While most people are familiar with 401Ks and company sponsored retirement plans which allow you to contribute pre-tax dollars from your paycheck, less people are aware of the variety of retirement systems that can be set up by individuals, small companies and the self-employed. In this article, we give a quick overview of some of the main options available to working US citizens.

Simplified Employee Pension (SEP) Plans

SEPs are simple, generic plans with low paperwork needs, and allow you to deduct up to 20% of your self-employment income, or up to 25% of your salary if you’re an employee of your own corporation. You are allowed to change the percentage annually, so if you have ups and downs in your business you won’t go bankrupt because you’re paying your own retirement plan. They can be opened as late as the extended due date of your income tax return, so you can do your taxes and then figure out how much you want to put in your SEP for maximum tax advantage. You can start one in minutes, generally free with no administrative expenses, with a bank, brokerage, or insurance company, and no annual government reports re required. They’re as easy as deductible IRAs but allow larger contributions.

Keogh, Profit Sharing, and Money Purchase Pension Plans

Keogh are less popular than when they were first introduced because of the heavy paperwork load involved. You can use profit-sharing plans or defined benefit pension plans, depending on how you want to leverage your business income. You do need to establish the plan before the end of the year, but you can defer contributions until the extended due date for that year’s tax return. The IRS requires an annual report, and you must have a plan document in the first year. Each year’s contribution must be calculated by an actuary, so your actuarial fees should be taxed onto the costs. And you must make the contribution defined by your actuary every year. Its primary advantage is that it permits larger contributions than any other type of program, making them great for older retirement planners.

Solo 401(k) plans

Solo 401(k) plans allow you to contribute more generously than other plans. You can contribute 100% of your first $15,000 ($20,000 if older than 50) of salary and then 25% (if compensated by company) or 20% (if sole proprietorship). The cap on the Solo 401(K) is $44,000 or $49,000 for those over 50. Solo 401(K)s require more paperwork than the other plans, so be advised.

Individual Retirement Accounts

An IRA makes a great additional retirement plan on top of any of the previously mentioned plans. The great thing about IRAs is that they are self-contained, flexible and not dependent on any particular company. You really have a lot of freedom to pick the best investment possible for your IRA. Also, the amount that you contribute to your IRA is independent of other retirement savings plans and thus doesn’t detract from the amount that you can contribute to them.

As you probably know, there are two types of IRAs. The first is called a Roth IRA where contributions are nondeductible, but earnings and other intraplan transactions are tax free; you have access to your contributions without penalty on demand, and eventually, when the IRA matures, you’ll be able to take out all your money without any federal tax liability.

If you think that you’ll be in a lower tax bracket after retirement than you are now, then consider a traditional IRA instead of the Roth. Keep in mind that IRA max contributions are the sum of both Roth and Traditional. In other words, if the max contribution is $4,000 then you would reach that max with $2,000 in a Roth and $2,000 in a Traditional.

Spousal Deductible IRAs are also available if your spouse contributes to a retirement plan at work. A Roth IRA is probably better in the long run, however, and a Spousal Deductible IRA is limited in many ways that can prove to be inconvenient.

For Employers

If you have employees, the SEP, Solo 401(k) or Keogh must be available to them as well. In all 401(k) and Keogh plans, you’ll find some significant complications, and in all cases you’ll find limitations to how much you pay yourself in your retirement plan in relation to how much you pay your employees. An IRA does not come with any of these complications, but the total contribution amounts are much lower than the other plans. Regardless, if you have employees you should talk with an employee benefits professional before opening any kind of retirement plan for yourself.