Checking the ROE of a Mutual Fund

ust as you should check the return on equity (ROE) of a stock, you should check the ROE of a mutual fund as a metric of fund management.

An ROE is a shorthand way of saying Return On Equity, the amount of money you get back when you invest cash. ROE is not just a simple number, but a way to determine how healthy a mutual fund is; this number helps you estimate the fund’s profitability, asset management, and financial leverage. A healthy ROE indicates that these three critical components of the mutual fund are also managed well by the fund’s caretakers. That’s because it is a very good indicator of how well management uses new and reinvested earnings to generate new cash.

ROE for a mutual fund can be calculated quickly and easily by taking a given year’s earnings (less extraordinary items) and dividing them by the average common shareholder’s equity. The year’s earnings are on the Consolidated Statement of Earnings for that year filed with the SEC, and is generally available in the Annual Report online. Make sure the Statement you look at is for a whole year, not a quarter. You can look at the quarters since the earnings should be fairly steady, though a whole year gives you a good sense of how the mutual fund manager used your money that year.

The shareholder’s equity is used because they are the only stakeholders in a company that do not have a fixed return. You can find the shareholder’s equity on the balance sheet, also generally available in the Annual Report. This is the difference between the total assets and the total liabilities. Shareholders equity refers to the assets generated by the business – the profits. The average shareholder’s equity is the shareholder’s equity divided by the number of shares held. This is often shown as a separate value called “book value.” If this number is relatively high, you’re probably looking at a healthy mutual fund.

But by dividing the single year’s earnings by the shareholder’s equity, you will get a percentage number, positive or negative, that is equal to the ROE.

With a mutual fund, though, you may want more than just one year’s ROE. You should check the ROE of several years, and compare them to see what kind of growth the fund has seen. Also look for a stable pattern of share purchases. A mutual fund that is selling a lot of shares in the year it has a great ROE may have a skewed ROE number, depending on how the accounting is done. You can use the ROE over several years to compare mutual funds, and you will begin to see how your mutual fund compares to others across the board. This gives you a much better idea of where to invest money in the future.

A similar strategy for using ROE as a metric of your mutual fund is to simply look at the average return on equity of the fund’s investments. The Microsoft Money Portal typically gives this information for mutual funds. The average return on equity will give you a general sense of the fund’s strategy as well as the quality of the companies that the fund manager selects. Look for a mutual fund that invests in companies with high return on equity but low price to earnings ratios.

ROE may also be called the “return on common equity” or the “return on average common equity.”

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.

Traditional vs. Roth IRAs

Investors should take advantage of the government endorsed tax advantages of IRA accounts by maximizing their contributions each year. This guide gives you some information to decide whether a Roth IRA or Traditional IRA is best for you.

An IRA is an Individual Retirement Account. All IRAs of any type are held in custody at a bank or a brokerage, rather then by the owner, and they may be invested in anything the custodian has access to. These investments options change from custodian to custodian. Because of the fact that IRA’s require extra work for the custodian bank or brokerage, they often involve an annual maintenance fee. Some custodians will waive the maintenance fee when your account reaches a certain level, such as $5,000.

IRAs come in two main flavors: Roth and Traditional. Choosing the right type of IRA is a matter of deciding whether you’ll pay taxes on your money: up front (Roth) or upon withdrawl (Traditional). To help you decide, make sure to read our step by step guide on prioritizing your retirement investments.

For a traditional IRA, the only criteria to be able to contribute is sufficient income to make the contribution. For it to be most effective, however, the contributor should pay attention to other eligibility requirements for tax deductibility of the contributions. These requirements are based on income, filing status, and the availability of other retirement plans. All transactions in the account, including contributions, are not subject to tax while funds remain in the account. Only when cash is withdrawn from the account for any reason does federal income tax apply.

The Roth IRA, on the other hand, works opposite. Contributions are subject to taxation; however, qualified withdrawals are made without tax penalty. It also has fewer restrictions on withdrawal than the traditional IRA.

In both cases, all transactions that take place within the account, like capital gains, dividends, and interest, are made with no tax liability.

In addition, income limits, both upper and lower, are different for the Roth and traditional IRA, with the traditional IRA having a lower overall income range.

Advantages of a Traditional IRA

In traditional IRAs, contributions are often tax-deductible; for Roth IRAs, contributions are not tax deductible. And because the taxes on the traditional IRA are charged after you take cash out of the IRA, if you expect your income to be less after retirement (putting you in a lower tax bracket), then you should take a traditional IRA for the tax advantage you will have.

You may be able to withdraw cash from a traditional IRA early if necessary for purposes such as qualified educational or medical expense, or for buying a first home. You should, however, be aware that the penalties may be substantial.

The traditional IRA is designed to provide retirement benefits for lower-income workers, so there are income eligibility requirements to take full advantage of the tax benefits.

Benefits of a Roth IRA

A Roth IRA is better than a traditional IRA for those with a lot of disposable income who anticipate a healthy, larger income after retirement. The Roth IRA also has very liberal disbursement requirements, and does not have a forced distribution age like the traditional IRA.

A traditional IRA must be disbursed at a specific time, and an annual minimum distribution will apply after the owner starts making withdrawals after age 59.5. There are no such requirements on a Roth IRA, though early withdrawals of earnings – not contributions – can incur heavy penalties. There are exceptions similar to the ones on the traditional IRA, though, such as buying a first home and paying qualified educational expenses.

Contributions to your Roth IRA can be withdrawn at any time, with no federal tax penalty. And if you convert a traditional IRA into a Roth IRA, after a “seasoning” period that is currently 5 years, you can withdraw up to the total of the converted amount just like a regular Roth IRA contribution – resulting in potentially significant tax savings.

Because Roth IRA contributions are made from after-tax income, and it is not taxed on disbursement, it’s easier to determine what your IRA is actually worth. Withdrawals up to the total of contributions are federal income tax free (check state regulations, though), and withdrawals of earnings are often also federal income tax free.

You can have both a Roth and a traditional IRA at the same time.

Why your expenses might decrease in retirement

It is certainly true that you should invest as much as possible for retirement. However, if you don’t have as much as all the “experts” tell you you should have, don’t fret just yet. The good news is that for most people, some major expenses tend to decrease or completely go away in retirement. Because of this, you may be able to live comfortably off of as much as 30% less than your current salary.

Even though retirement will bring a level of simplification to your life – preparing to go there is going to be very complicated. There are so many factors that have to be considered and decisions that have to be made to make sure that when you do reach retirement age, all of your carefully laid out plans will have borne fruit and you can finally enjoy this new phase in your life.

The most important thing that you have to contend with on your retirement is the fact that, generally, you won’t be earning an income anymore. For most people who either have not set up a business or are not in a field where they can do consultancy, the salary “well” dries up when you retire and the accumulation phase of your life nears its end. This means that you will have to subsist on the savings you have accumulated over the years and any investments or pensions that you have drawn up before.

For most retirees the main area of concern is whether their funds will last them for the rest of their lives. How much of the money that they have can they safely spend each year to ensure that their funds will not run out.

These questions all come down to the fear that your retirement funds will not be enough.

The good news though is that there are some expenses that will decrease when you go into retirement and this will definitely help in extending your funds. Many of the things that you pay or spend for now will most likely disappear or decrease when you reach retirement. Among these are:

Work-related expenses. You can basically write off any work related expenses when you retire. You won’t have to commute everyday and thus eliminate taxi or subway fare, or if you drive, the cost of getting gasoline for your car. Another work-related expense that will be eliminated is the cost of buying professional wardrobe. Corporate dressing can really put a big burden on your budget but upon retirement you can say goodbye to this expense. One minor expense that is also eliminated is the cost of decorating your cubicle. Insignificant, really, but when you retire every cent saved will help.

Taxes. There are some taxes that you won’t have to pay anymore when you retire. Most of these are Social Security related taxes. Depending on the type of retirement investment, you may not have to pay any taxes at all.

Retirement plan contributions. When you retire you stop paying your retirement plan premiums. The good thing is, all of your sacrifice now pays off as your retirement plan now starts paying you instead.

Mortgage payments. If in your projected plan, you will finish paying off your mortgage by the time you retire, then that’s one less payment to worry about. Of course, if you fall for one of the new 50 year mortgages, you may be paying well into your 80s.

Downsizing. A change in your personal financial outlook will also have a big impact in lessening your expenses upon retirement. The first thing that retirees often do for practical reasons is to downsize. There’s no more need to maintain a five-bedroom house if all of your kids are grown up and have families of their own. There are some who even decide to leave the city and live in the country where the cost of living is significantly lower.

Whatever the case, chances are that many of your current monthly expenses will be gone in retirement. Of course, there may be new types of expenses related to health or even those monthly vacations you’ve been dreaming about! But keep in mind that when it comes to the basics, chances are that you will be downsizing your expenses and have more cash left over for living well.

Keep that in mind if you’re feeling the pressure of retirement looming. But for now, keep investing and everything should be fine.

Retirement Investing and Tax-Efficiency

The average investor isn’t aware of the fact that there is a huge difference in the total return of a standard stock investment versus a retirement investment.

Thankfully, the United States goverment has encouraged retirement savings by adding the benefit of tax efficiency both as it grows and either at the purchase or sale. In other words, you can either put pre-tax income into your retirement and postpone paying taxes until you retire, or you can put post-tax income in now, and never have to pay taxes again.

Despite the benefits of tax-efficient retirement investing, something that’s frequently forgotten when you invest for retirement is to actually consider the role taxes play and the effect they will have on the total return of your stocks. Keeping this in mind will help you make wise retirement investing decisions, both when you put the money in and when you take the money out.

You may have invested carefully in great stocks that performed well, and you may have hedged your 401(k). But what happens when you cash it in? Do you really know what taxes are going to do to you? If you’re like most people, the answer is no. Do you know, really well, exactly how much you’re going to need for retirement? Again, if you’re like most people, the best you can do is give a vague answer based on a guesstimate.

But the key to a successful retirement is knowing and understanding the relationship that your investments have to taxes. Here are some things to think about to maximize you money. First, calculate how much you’ll need for retirement:

  • What kind of lifestyle you want and how much you’ll need annually to support it.
  • How much your target number for your day of retirement should be.
  • How long you’ll probably be retired.
  • Where you’re going to live and whether you will own or rent your home.
  • How to provide medical and other insurance for yourself and your family.
  • How you’re going to spend the days, and what expenses are associated with that.

From these questions, you will have a realistic idea of how much you’ll need for retirement. Don’t forget to figure in the sale of your current house if you’re going to move, too; that can help you afford the lovely home in the Bahamas you’re set on. Then figure that you’re going to need about $25 in savings and investment for every $1 per year you need to live. This ensures you can live mostly on interest without touching your principal. You should probably also assume that your savings are the only income you will have; we don’t know what’s going to happen in this day of pension fund reneging and changing Social Security.

Once you have your numbers straight, you need to take a look at how taxes will cut into them. Do you have a tax-deferred pension vehicle, a 401(k) or an IRA? These are great for keeping your income taxes lower, and for using money from deferred taxes to build up your compound interest, but eventually you will have to pay the piper in the form of Uncle Sam.

In the case of the 401(k) and the Traditional IRA, your earnings are not taxed until you retire and start drawing the money, so it would be better if you were in a lower tax bracket during retirement. With a Roth IRA, you pay taxes before you put the money into retirement, and all your earnings are taken out tax free. This is the strategy to use if you plan to be in a higher tax bracket when you retire.

The cut you take from taxes would be easy to figure into your whole retirement plan – except that the tax rate is not predictable. It may be higher or lower than today’s; you just don’t know. This is where you need to start betting (or making educated guesses!). Do you think taxes will be higher or lower when you retire. Chances are, if it’s going to be ten years or more, and you are acquire wealth during that time, they’ll be higher. There is very little chance they’ll be lower. So take your current tax bracket, add about 1/3 of its amount to it, and figure that into your retirement numbers as the amount you’re probably going to be taxed. It’s an additional expense, but you have to plan for it.

But why, you might ask, should I use the tax deferred dollars if I’m just going to have to pay them eventually plus capital gains? Because the tax money in your account is free interest-drawing capital. This means that your money grows faster and goes to work harder. And because if you’re using a 401(k), your employer is probably matching at least a portion of your investments. Once you reach the top of the employee matching bracket, you might want to consider investing in a Roth IRA, which have better tax structuring for you when you retire and which also defer taxes.