One of the most important problems facing a person at the cusp of retirement is how to survive financially during the golden years. A healthy 65-year old man will live about 19 more years, on average. A healthy 65-year old woman will live about 22 more years, on average. Those are just averages. Some won't make it that far. But some others will live to their 90's. There's no simple answer to the problem of financing a long retirement. Much depends on the person's individual circumstances. Perhaps you, your parents, or your grandparents are facing this question. Here are a few thoughts.
1. Most retiring Americans will have less than $100,000 in savings and a house. They will be entitled to Social Security, and the lucky ones will get a pension. The pension will probably not be adjusted for inflation. A person or family in this situation should try to live on Social Security and any pension payments. Hold onto the savings and the house for the big expenses that may well be coming. Many health care costs (like assisted living) aren't covered by Medicare or Medicaid. Also, large purchases like a new car are best made with cash. When you're 70, you don't want to enrich banks with interest payments.
2. For retirees with substantial savings, such as $500,000 or $1,000,000, the conventional wisdom is that if you retire around 65, have your money invested in a diversified portfolio and figure on living about 20 more years, you can withdraw about 4% of the savings the first year of retirement, and then adjust the amount of withdrawals for inflation each year thereafter. For example, if you start with $1,000,000, withdraw $40,000 in year one of your retirement. We'll assume that inflation remains at its historical average of about 3% per year. In year two, withdraw $41,200 (the original $40,000 plus $1,200 or 3%, for inflation). In year three, withdraw $42,436 ($41,200 plus $1236, or 3% more, for inflation). Remember that you'll also have Social Security and perhaps a pension, so the withdrawal probably won't be your only income.
If your family has the longevity gene and you figure your retirement might last 30 years, start with a 3% withdrawal and adjust for inflation. To use our $1,000,000 example, withdraw $30,000 in the first year of your retirement, and adjust upwards for inflation in succeeding years.
Where do these 3% and 4% numbers come from? A mathematical technique called a Monte Carlo simulation. It is a way of calculating probabilities--in this case, the probability that you might outlive your retirement savings. Is the Monte Carlo technique foolproof? Not more so than anything else that human beings have come up with. But it's been widely analyzed in the last few years and is seen as a valid way of dealing with the problem. For more on Monte Carlo simulation, go to http://www.businessweek.com/2001/01_04/b3716156.htm.
3. Another approach to managing retirement savings is the time-honored rule of spending the earnings, but never touching the principal. One advantage to this approach is you will always have your principal. Your spending may fluctuate widely from year to year, especially if the stock market does one of its periodic belly flops. But your principal will remain. Its value will erode because of inflation. You can counteract the inflation by not spending all your income in good years. Set some aside and give your principal a boost. You'll be glad you did if, later on, you hit choppy water.
Spending only investment earnings and preserving principal will mean that, on average, you'll probably spend less than the 3% or 4% level that the Monte Carlo simulation approach prescribes. But if you get more peace of mind from never touching your principal, then don't touch your principal. Your retirement years should be as worry-free as possible.
4. One thing that all this tells you is that saving as much as possible is the key to a comfortable retirement. Withdrawing 3% or 4% a year may seem very conservative. But if you have $1,000,000 or $2,000,000 saved up, 3% or 4% of those totals is a pretty decent sum of money, especially if you add Social Security on top of it.
5. Some people advocate the use of annuities to make retirement savings last. There are many types of annuities, and most of them are suitable only for wealthy people. But if you have $500,000 or more, certain kinds of annuities might make sense. Ones that provide a predictable monthly payment (such as a lump sum immediate fixed annuity or a lump sum inflation adjusted annuity) might help you avoid spending the rest of your savings too fast. But remember that you lose the money you invest in the annuity if you die early. For example, if you are 65 and invest $200,000 in a lump sum immediate fixed annuity, you might get a monthly payment around $1,300 at current interest rates. But if you die the next month, you lose all $200,000. And there's also the risk that the insurance company that sells you the annuity may go out of business. If so, you could be out of luck. Annuities may be right for some people. But you have to think about them carefully. For more on annuities, see http://blogger.uncleleosden.com/2007/06/annuities.html.
6. Work as long as possible to build up your Social Security credits, and your pension credits if you're entitled to a pension. The more continuing income you have, the less you'll need to tap into savings. To learn about how Social Security determines your credits, go to http://blogger.uncleleosden.com/2007/05/mysteries-of-social-security-retirement.html. Also consider delaying the time when you start to collect Social Security benefits. That will increase the size of your monthly payment. See http://blogger.uncleleosden.com/2007/05/mysteries-of-social-security-retirement_02.html.
How you approach the problem of managing your retirement money is a matter of personal choice. Some want to live it up while they are still healthy. They travel a lot and get to know many maitre d's. They don't care about leaving an estate behind. Others want to make sure they don't run out of money and spend cautiously. They know it's hard to recover from financial setbacks when you're 75 or 80. Early spending in retirement is costly to your long term financial security, but it's not wrong. Whatever your choice, make sure you understand the consequences.
For more ideas on dealing with your money worries, please go to http://www.widowsquest.com/how-to-solve-your-money-worries/
Food News: the hot dog eating champ could be dethroned. http://www.wtop.com/?nid=456&sid=1170157.
Friday, June 29, 2007
Wednesday, June 27, 2007
The Subprime Mortgage Mess on Wall Street
You're probably familiar with the problems on the home front created by subprime and other adjustable payment mortgages. Monthly payments are rising. Many homeowners are defaulting, and some face foreclosure. The problems are particularly acute in areas where housing prices rose abruptly and have now plummeted, or where economic distress is spreading.
The pain has spread to Wall Street. In the last week, the financial press has reported on difficulties at two hedge funds sponsored by an investment bank called Bear Stearns, which had invested indirectly in subprime mortgages. Bear Stearns agreed to provide a $3.2 billion loan to stabilize one fund. It's unclear what will happen to the other fund. What's going on here? How did we get from some defaulting homeowners in places like Michigan and Florida to a $3.2 billion bailout on Wall Street?
Here's an overview. We are speaking generally, and not about the Bear Stearns-sponsored hedge funds.
Fifty years ago, mortgage lending was primarily done by specialized banks usually called "Savings and Loan Associations" or "Building and Loan Associations." Broadly referred to as thrift institutions, these specialized banks held onto many or most of the mortgage loans they made. They earned profits from the difference between the interest they paid to depositors and the higher interest rate they charged for mortgage loans. Interest rates were stable in those days, and thrift institutions were able to make a comfortable living without working real hard.
In the 1970's, however, interest rates began to fluctuate widely, and the thrifts had a harder time maintaining profits. Regulatory restrictions on them were loosened in the early 1980's, but that resulted in a some poorly conceived lending strategies that led to the collapse of a number of thrift institutions. By 1990, the thrift industry was diminished and other players, like mortgage companies and banks, began to make more mortgage loans. They, however, did not hold onto the loans, but instead tended to sell them.
A mortgage provides a flow of cash, and can be bought or sold like a bond or other investment providing a cash flow. Investment banks pool large numbers of mortgages together into an entity often called a CDO (or collateralized debt obligation). These mortgage pools provide a large, aggregate flow of cash. Investment banks "subdivide" the aggregate flow of cash into classes called "tranches." Each tranche has different claims on the cash flowing from the pool of mortgages. The result is a tier of tranches, with the most "senior" having the best claim to the cash flow from the mortgage pool, the next most senior having the second-best claim, and so on, down to the most "junior" tranche, which basically has a speculative claim to the residual value of the pool.
The CDO issues bonds that correspond with the various tranches. The most senior bonds have the best claim to payment from the mortgage pool. The next most senior bonds have the second-best claim, etc. The potential returns from these bonds varies by the position of the bond in the hierarchy for repayment. The interest paid on the most senior bond will be the lowest, since its likelihood of repayment is the highest. The interest rate on the more junior bonds will increase, since they have greater risk of not being fully repaid. The most junior bond may even be called the "equity tranche," a term that reflects its high risk levels (not unlike the risks of equity investments like stocks).
Why did Wall Street create these CDO's? Because subdividing the mortgage pool into different tranches allowed them to sell a variety of investments that might serve the needs of different investors. Some investors want conservative, reliable investments with a low risk of default. They would be interested in the senior bonds. Other investors want bonds that pay a higher return, even if there's a greater risk of default. They'll take the risk of the default in order to get a better return, and would be interested in the more junior bonds. Some investors want to speculate, and the equity tranche, with its high returns and high risks--might fit into their strategy.
There has been, as you probably know, a hedge fund craze in recent years. Hedge funds have proliferated, and as their numbers have grown, their interest in new and different investments has grown. CDOs have drawn their interest. Hedge funds have borrowed, sometimes heavily, to invest in CDO bonds. Borrowing increases the quantity of bonds a hedge fund can buy and therefore leverages the returns it might receive if all goes well. However, borrowing also leverages the losses the hedge fund would receive if things go badly.
Things have gone badly. The real estate boom is over in most markets and defaults are occurring at well above normal levels. CDOs aren't receiving the cash flow they expected, and CDO investors like hedge funds are taking losses. Those that invested on a leveraged basis may be taking sharp losses.
How did this happen? On the most basic level, the market pros didn't correctly predict the level of defaults. That means they over-estimated the investment quality of many CDO bonds, and priced them too high. Losses are now resulting.
Who's responsible? Homeowners who took out mortgages they should have known they couldn't pay? Mortgage brokers, mortgage companies and banks that made loans to people who shouldn't have qualified? Investment banks packaging CDOs that didn't look close enough at the quality of the mortgages they were buying? Investors that borrowed to invest in illiquid assets like many CDO bonds? All of the above? Now that things are hitting the fan, Congress is holding hearings, government agencies are investigating, and lawsuits will be filed.
There has been very little regulation of the mortgage markets, especially at the Wall Street level, where hedge funds roam unsupervised among herds of CDOs. An absence of regulation sometimes allows markets to grow and evolve more quickly. But markets are created by humans and are therefore capable of error (as is evidenced by all the bubbles, booms and busts of recent years). The enormous growth of the mortgage market included many loans that never should have been made in the first place, and, once made, never should have been purchased for packaging in CDOs. Some of the losses from CDO investments are falling on wealthy individuals who invested in hedge funds to get money to buy a larger yacht. Such a shame. But other losses are falling on pension funds that ordinary people count on for retirement, or on university endowments that could help cover some of the costs of your child's education. In the end, many people will be hurt.
Congress, government agencies and state governments will be confronted by the question whether the mortgage industry should be more heavily regulated. If thrift institutions were still at the heart of the mortgage business, the problems we see today might never have happened. Thrift institutions were heavily regulated, and it's highly doubtful they would have been allowed to make the large numbers of low doc/no doc, don't-have-the-means-to-repay subprime mortgage loans that now weigh down on parts of Wall Street. Had those loans never been made, the losses wouldn't have occurred. And let's not think that subprime loans are a boon to home ownership. Extending loans that people can't pay and result in foreclosures not only doesn't increase home ownership, it damages the borrowers' credit ratings and impairs their future ability to own a home.
On an individual level, stay away from loans that have the potential for increasing monthly payments. As we discussed earlier, the right mortgage loan helps you build wealth. http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html.
Animal News: the search for Bigfoot continues. http://www.wtop.com/?nid=456&sid=1175579.
The pain has spread to Wall Street. In the last week, the financial press has reported on difficulties at two hedge funds sponsored by an investment bank called Bear Stearns, which had invested indirectly in subprime mortgages. Bear Stearns agreed to provide a $3.2 billion loan to stabilize one fund. It's unclear what will happen to the other fund. What's going on here? How did we get from some defaulting homeowners in places like Michigan and Florida to a $3.2 billion bailout on Wall Street?
Here's an overview. We are speaking generally, and not about the Bear Stearns-sponsored hedge funds.
Fifty years ago, mortgage lending was primarily done by specialized banks usually called "Savings and Loan Associations" or "Building and Loan Associations." Broadly referred to as thrift institutions, these specialized banks held onto many or most of the mortgage loans they made. They earned profits from the difference between the interest they paid to depositors and the higher interest rate they charged for mortgage loans. Interest rates were stable in those days, and thrift institutions were able to make a comfortable living without working real hard.
In the 1970's, however, interest rates began to fluctuate widely, and the thrifts had a harder time maintaining profits. Regulatory restrictions on them were loosened in the early 1980's, but that resulted in a some poorly conceived lending strategies that led to the collapse of a number of thrift institutions. By 1990, the thrift industry was diminished and other players, like mortgage companies and banks, began to make more mortgage loans. They, however, did not hold onto the loans, but instead tended to sell them.
A mortgage provides a flow of cash, and can be bought or sold like a bond or other investment providing a cash flow. Investment banks pool large numbers of mortgages together into an entity often called a CDO (or collateralized debt obligation). These mortgage pools provide a large, aggregate flow of cash. Investment banks "subdivide" the aggregate flow of cash into classes called "tranches." Each tranche has different claims on the cash flowing from the pool of mortgages. The result is a tier of tranches, with the most "senior" having the best claim to the cash flow from the mortgage pool, the next most senior having the second-best claim, and so on, down to the most "junior" tranche, which basically has a speculative claim to the residual value of the pool.
The CDO issues bonds that correspond with the various tranches. The most senior bonds have the best claim to payment from the mortgage pool. The next most senior bonds have the second-best claim, etc. The potential returns from these bonds varies by the position of the bond in the hierarchy for repayment. The interest paid on the most senior bond will be the lowest, since its likelihood of repayment is the highest. The interest rate on the more junior bonds will increase, since they have greater risk of not being fully repaid. The most junior bond may even be called the "equity tranche," a term that reflects its high risk levels (not unlike the risks of equity investments like stocks).
Why did Wall Street create these CDO's? Because subdividing the mortgage pool into different tranches allowed them to sell a variety of investments that might serve the needs of different investors. Some investors want conservative, reliable investments with a low risk of default. They would be interested in the senior bonds. Other investors want bonds that pay a higher return, even if there's a greater risk of default. They'll take the risk of the default in order to get a better return, and would be interested in the more junior bonds. Some investors want to speculate, and the equity tranche, with its high returns and high risks--might fit into their strategy.
There has been, as you probably know, a hedge fund craze in recent years. Hedge funds have proliferated, and as their numbers have grown, their interest in new and different investments has grown. CDOs have drawn their interest. Hedge funds have borrowed, sometimes heavily, to invest in CDO bonds. Borrowing increases the quantity of bonds a hedge fund can buy and therefore leverages the returns it might receive if all goes well. However, borrowing also leverages the losses the hedge fund would receive if things go badly.
Things have gone badly. The real estate boom is over in most markets and defaults are occurring at well above normal levels. CDOs aren't receiving the cash flow they expected, and CDO investors like hedge funds are taking losses. Those that invested on a leveraged basis may be taking sharp losses.
How did this happen? On the most basic level, the market pros didn't correctly predict the level of defaults. That means they over-estimated the investment quality of many CDO bonds, and priced them too high. Losses are now resulting.
Who's responsible? Homeowners who took out mortgages they should have known they couldn't pay? Mortgage brokers, mortgage companies and banks that made loans to people who shouldn't have qualified? Investment banks packaging CDOs that didn't look close enough at the quality of the mortgages they were buying? Investors that borrowed to invest in illiquid assets like many CDO bonds? All of the above? Now that things are hitting the fan, Congress is holding hearings, government agencies are investigating, and lawsuits will be filed.
There has been very little regulation of the mortgage markets, especially at the Wall Street level, where hedge funds roam unsupervised among herds of CDOs. An absence of regulation sometimes allows markets to grow and evolve more quickly. But markets are created by humans and are therefore capable of error (as is evidenced by all the bubbles, booms and busts of recent years). The enormous growth of the mortgage market included many loans that never should have been made in the first place, and, once made, never should have been purchased for packaging in CDOs. Some of the losses from CDO investments are falling on wealthy individuals who invested in hedge funds to get money to buy a larger yacht. Such a shame. But other losses are falling on pension funds that ordinary people count on for retirement, or on university endowments that could help cover some of the costs of your child's education. In the end, many people will be hurt.
Congress, government agencies and state governments will be confronted by the question whether the mortgage industry should be more heavily regulated. If thrift institutions were still at the heart of the mortgage business, the problems we see today might never have happened. Thrift institutions were heavily regulated, and it's highly doubtful they would have been allowed to make the large numbers of low doc/no doc, don't-have-the-means-to-repay subprime mortgage loans that now weigh down on parts of Wall Street. Had those loans never been made, the losses wouldn't have occurred. And let's not think that subprime loans are a boon to home ownership. Extending loans that people can't pay and result in foreclosures not only doesn't increase home ownership, it damages the borrowers' credit ratings and impairs their future ability to own a home.
On an individual level, stay away from loans that have the potential for increasing monthly payments. As we discussed earlier, the right mortgage loan helps you build wealth. http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html.
Animal News: the search for Bigfoot continues. http://www.wtop.com/?nid=456&sid=1175579.
Monday, June 25, 2007
Why the Federal Reserve Matters
If you are nothing more than a casual observer of the financial markets, you are well aware of the markets' obsession with the intentions of the Federal Reserve Board. Just from reading a newspaper or financial website, you'll learn that the Fed influences the direction of interest rates. The prices of stocks, bonds and other investments will change, sometimes rapidly, as a result of what Fed does, says or even doesn't do or say, with respect to interest rates. Perhaps you've wondered what gives with the Fed, and why it has so much influence and power. Here's a brief overview, something to keep in mind when you're reading about this coming week's Fed meeting.
The Federal Reserve System is America's central bank. It doesn't offer consumer checking accounts or credit cards. Rather, it is the bank for other banks. When other banks need a loan, they can borrow from the Fed. Why would a bank need a loan? Because banks sometimes don't have enough cash on hand--their customers may demand more cash than the bank has available (remember Jimmy Stewart in "It's a Wonderful Life"?). Normally, banks borrow from other banks (with the interest rate on these interbank loans called the "federal funds rate").
The Fed can influence the federal funds rate (also called the "fed funds rate") by buying and selling bonds through a trading operation at the Federal Reserve Bank of New York. But the Fed generally needs only announce a target for the fed funds rate and the market will listen. Interest rates across the nation and around the world will react almost instantaneously. Prices of stocks, precious metals and other investments will also react to changes in the Fed's target for the fed funds rate, since all investments have both an absolute price (the price in dollars) and a comparative price (their value in comparison to alternative investments).
Why do interest rates matter so much to the Fed? Because its job is to try to control inflation, and it can influence the rate of inflation by changing interest rates. Inflation--in the sense of a general rise in prices overall--is, in part, the product of the availability of money. The more money there is, the greater the risk that prices will rise.
Where does money come from? Mostly from lending activity. For example, when a bank takes money a customer has deposited and lends it out (which is what banks do), the borrower has acquired buying power he or she didn't previously have. That effectively increases the money supply.
The lower interest rates are, the more people will borrow. (Remember your Econ 101: if something is cheap, people buy more of it; and credit is no exception.) The more they borrow, the larger the money supply and the greater the potential for inflation. So when the Fed sees inflationary storm clouds on the horizon, it will raise its target for the fed funds rate. Other times, when the Fed is nervous but not entirely sure inflation threatens, it will hold rates steady but issue a statement indicating its concern. That statement tends to keep interest rates from falling and therefore helps to control the amount of credit available.
What will the Fed do at this coming week's meeting? Darned if we know. But keep in mind the Fed's ultimate goal.
Controlling inflation is a very important job. Inflation erodes hard earned wealth and undermines public confidence. In extreme situations (like Germany of the 1920's or China of the 1920's and 30's), high levels of inflation contributed to social unrest that paved the way for extremist regimes (remember that guy, Adolf, and that fellow, Mao?). Even though the Fed's interest rate policy may cause gastronomic distress for stock market speculators, if the Fed succeeds in holding the line on inflation, it will pave the way for long term prosperity.
To protect your retirement plan from inflation, increase the amount you save each year by the rate of inflation. See our earlier blog at http://blogger.uncleleosden.com/2007/04/how-to-whip-inflation-now-and-retire.html.
Animal News: the world's ugliest dog. http://www.wtop.com/?nid=456&sid=1173505.
The Federal Reserve System is America's central bank. It doesn't offer consumer checking accounts or credit cards. Rather, it is the bank for other banks. When other banks need a loan, they can borrow from the Fed. Why would a bank need a loan? Because banks sometimes don't have enough cash on hand--their customers may demand more cash than the bank has available (remember Jimmy Stewart in "It's a Wonderful Life"?). Normally, banks borrow from other banks (with the interest rate on these interbank loans called the "federal funds rate").
The Fed can influence the federal funds rate (also called the "fed funds rate") by buying and selling bonds through a trading operation at the Federal Reserve Bank of New York. But the Fed generally needs only announce a target for the fed funds rate and the market will listen. Interest rates across the nation and around the world will react almost instantaneously. Prices of stocks, precious metals and other investments will also react to changes in the Fed's target for the fed funds rate, since all investments have both an absolute price (the price in dollars) and a comparative price (their value in comparison to alternative investments).
Why do interest rates matter so much to the Fed? Because its job is to try to control inflation, and it can influence the rate of inflation by changing interest rates. Inflation--in the sense of a general rise in prices overall--is, in part, the product of the availability of money. The more money there is, the greater the risk that prices will rise.
Where does money come from? Mostly from lending activity. For example, when a bank takes money a customer has deposited and lends it out (which is what banks do), the borrower has acquired buying power he or she didn't previously have. That effectively increases the money supply.
The lower interest rates are, the more people will borrow. (Remember your Econ 101: if something is cheap, people buy more of it; and credit is no exception.) The more they borrow, the larger the money supply and the greater the potential for inflation. So when the Fed sees inflationary storm clouds on the horizon, it will raise its target for the fed funds rate. Other times, when the Fed is nervous but not entirely sure inflation threatens, it will hold rates steady but issue a statement indicating its concern. That statement tends to keep interest rates from falling and therefore helps to control the amount of credit available.
What will the Fed do at this coming week's meeting? Darned if we know. But keep in mind the Fed's ultimate goal.
Controlling inflation is a very important job. Inflation erodes hard earned wealth and undermines public confidence. In extreme situations (like Germany of the 1920's or China of the 1920's and 30's), high levels of inflation contributed to social unrest that paved the way for extremist regimes (remember that guy, Adolf, and that fellow, Mao?). Even though the Fed's interest rate policy may cause gastronomic distress for stock market speculators, if the Fed succeeds in holding the line on inflation, it will pave the way for long term prosperity.
To protect your retirement plan from inflation, increase the amount you save each year by the rate of inflation. See our earlier blog at http://blogger.uncleleosden.com/2007/04/how-to-whip-inflation-now-and-retire.html.
Animal News: the world's ugliest dog. http://www.wtop.com/?nid=456&sid=1173505.
Thursday, June 21, 2007
For Consumers and Parents: May 2007 Product Recalls
Government websites have reputations for being difficult to navigate, hard to understand and not terribly useful. That's not always the case. The Consumer Product Safety Commission lists consumer product recalls each month. Some of the recalls are rather disturbing. Here are some from the May 2007 recall list, for items that could potentially cause serious injury or worse:
Children's shoes: Airwalk Compel Shoes a choking hazard. (Sold at Payless ShoeSource, Payless.com and Pamida.) http://www.cpsc.gov/cpscpub/prerel/prhtml07/07171.html.
Discovery Bunny Books a choking hazard. (Sold by Bookspan and bookspan.com.)http://www.cpsc.gov/cpscpub/prerel/prhtml07/07551.html.
GE Dishwashers a fire hazard. (Made by General Electric, sold at a lot of places.) http://www.cpsc.gov/cpscpub/prerel/prhtml07/07190.html.
Ellemenno brand Girls Capri Pants with Snap Roll Cuff a choking hazard. (Sold by Mervyns). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07187.html.
Evenflo Embrace Infant Car Seat/Carrier handle problem can result in child falling. (Manufactured by Evenflo Company Inc.; sold at a lot of places). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07186.html.
Parents Magazine Record-a-voice Toy Cell Phone a choking hazard. (Manufactured by Battat Inc.; sold at Target). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07178.html.
Soft Blocks Tower Toys (on Graco Baby Einstein discover and play Activity Centers) a choking hazard. (Manufactured by Graco Children's Products Inc., and sold at a lot of places). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07176.html.
Polaris 2006 Hawkeye ATVs for steering and control problems (2 recalls). (Manufactured by Polaris Industries Inc. and sold by Polaris dealers). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07553.html and http://www.cpsc.gov/cpscpub/prerel/prhtml07/07552.html.
There are many other recalls. Here's a link to the complete recall list for May 2007: http://www.cpsc.gov/cpscpub/prerel/prerelmay07.html. It's cliche-ish to say that the world is a dangerous place. But it's also true.
More on kids: Will the government let you name your child "4real"? http://www.wtop.com/?nid=456&sid=1172033.
Children's shoes: Airwalk Compel Shoes a choking hazard. (Sold at Payless ShoeSource, Payless.com and Pamida.) http://www.cpsc.gov/cpscpub/prerel/prhtml07/07171.html.
Discovery Bunny Books a choking hazard. (Sold by Bookspan and bookspan.com.)http://www.cpsc.gov/cpscpub/prerel/prhtml07/07551.html.
GE Dishwashers a fire hazard. (Made by General Electric, sold at a lot of places.) http://www.cpsc.gov/cpscpub/prerel/prhtml07/07190.html.
Ellemenno brand Girls Capri Pants with Snap Roll Cuff a choking hazard. (Sold by Mervyns). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07187.html.
Evenflo Embrace Infant Car Seat/Carrier handle problem can result in child falling. (Manufactured by Evenflo Company Inc.; sold at a lot of places). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07186.html.
Parents Magazine Record-a-voice Toy Cell Phone a choking hazard. (Manufactured by Battat Inc.; sold at Target). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07178.html.
Soft Blocks Tower Toys (on Graco Baby Einstein discover and play Activity Centers) a choking hazard. (Manufactured by Graco Children's Products Inc., and sold at a lot of places). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07176.html.
Polaris 2006 Hawkeye ATVs for steering and control problems (2 recalls). (Manufactured by Polaris Industries Inc. and sold by Polaris dealers). http://www.cpsc.gov/cpscpub/prerel/prhtml07/07553.html and http://www.cpsc.gov/cpscpub/prerel/prhtml07/07552.html.
There are many other recalls. Here's a link to the complete recall list for May 2007: http://www.cpsc.gov/cpscpub/prerel/prerelmay07.html. It's cliche-ish to say that the world is a dangerous place. But it's also true.
More on kids: Will the government let you name your child "4real"? http://www.wtop.com/?nid=456&sid=1172033.
Debit or Credit?
If you have the choice of a debit card or a credit card, which should it be? The answer basically depends on your individual preferences. If you want a mechanism to make you live within your means, a debit card limits you to what's in your bank account. However, watch out for the temptation to tap into any overdraft protection you might have on your checking account--that's really nothing more than a line of credit with interest charges. And you have to monitor your bank account's balance continually, because debits that cause overdrafts are subject to overdraft fees. If you're the type to charge even your mid-afternoon coffee, a small charge that causes an overdraft can result in a fee much larger than the charge itself.
On the other hand, if you have an uneven income and/or uneven expenses, having the credit line provided by a credit card may be a convenience. The alternative would be to have a pool of savings that you could dip into as and when you needed it. But not everyone can set aside enough money to create that pool of cash. And for large purchases, credit cards are a must, unless you have a lot of cash saved up.
When it comes to theft or fraud, though, the rules tilt in favor of using a credit card. In general, your responsibility for unauthorized charges on a credit card is limited to $50, and some credit card companies waive even that. For debit cards, the limit is $50 if you report the loss of the card within two business days. But it goes up to $500 if you report the loss of the card after two business days. And if you're more than 60 days late reporting the loss of the card, you could be responsible for every penny in your bank account, plus the maximum amount of any overdraft protection on your account.
So how likely is it that you'd wait more than 2 days, or 60 days, before reporting the loss of a debit card, you ask? Not likely if someone pinches your wallet and you discover the loss minutes or an hour or two later. But that could be enough time for a clever crook to drain your bank account. Or, what if you use the debit card to buy something over the Internet, and a sleezemeister in a distant time zone steals your debit card number? You may not realize that you're in trouble until checks start bouncing and your bona fide charges are refused at the checkout lane. By then, your bank account could be empty and your overdraft protection entirely burned up. And all the legitimate checks and electronic payments you tried to send will bounce.
It could take the bank as many as 10 days to restore the funds to your bank account (because they'll want to investigate and make sure your claim of unauthorized use of the card is accurate). Unless you have a second bank account somewhere (preferably at a different bank for the sake of safety), you will have no cash, as in zero, zip, nada. And if this is a joint bank account for you and your spouse, you could be looking at a night or two on the living room couch.
Then, there's the question of all those checks and electronic payments that are bouncing. Maybe the bank will restore your funds eventually. But what about all the fees that other people are charging you for bouncing a check, or being late in making payment? You'll be late because you have to get them to resubmit the check to the bank after your account is restored, or because you'll have to resend the electronic payment after there's some money in the account to send. Ideally, everyone will be nice to you and not impose these fees. But you'll have to do a lot of explaining, and maybe a little begging and pleading.
With a credit card, your cash remains untouched, your legitimate checks and electronic payments won't bounce, and you're liable for $50 max. Yes, you'll have to contact the credit card company, and the sooner the better. But your worst case scenario is an argument with them about whether you owe them $50 or not, and many won't even hassle you over that.
Ultimately, the choice of credit or debit is a matter of personal preference. But if you prefer debit, be very, very careful with the card. Don't let others see your PIN. Don't use the card for Internet purchases. And keep track of your bank account balance. With a credit card, you have to rely on something else to control your spending besides the purchasing power of the card.
With either kind of card, you have to look over your monthly account statements carefully. These days, you never know if your card number has been stolen and a few charges quietly slipped onto your
account. A clever crook might do that to reduce the chances of detection. If you're not careful, you could be stuck with those charges, not because you'd necessarily be required to pay them but because you simply didn't notice them.
For more personal finance ideas, go to http://howtomakeamilliondollars.blogspot.com/2007/09/festival-of-under-30-finances.html.
Crime News: Stolen Homer Simpson statue recovered. http://www.wtop.com/?nid=456&sid=1171977. Whew. We're so relieved.
On the other hand, if you have an uneven income and/or uneven expenses, having the credit line provided by a credit card may be a convenience. The alternative would be to have a pool of savings that you could dip into as and when you needed it. But not everyone can set aside enough money to create that pool of cash. And for large purchases, credit cards are a must, unless you have a lot of cash saved up.
When it comes to theft or fraud, though, the rules tilt in favor of using a credit card. In general, your responsibility for unauthorized charges on a credit card is limited to $50, and some credit card companies waive even that. For debit cards, the limit is $50 if you report the loss of the card within two business days. But it goes up to $500 if you report the loss of the card after two business days. And if you're more than 60 days late reporting the loss of the card, you could be responsible for every penny in your bank account, plus the maximum amount of any overdraft protection on your account.
So how likely is it that you'd wait more than 2 days, or 60 days, before reporting the loss of a debit card, you ask? Not likely if someone pinches your wallet and you discover the loss minutes or an hour or two later. But that could be enough time for a clever crook to drain your bank account. Or, what if you use the debit card to buy something over the Internet, and a sleezemeister in a distant time zone steals your debit card number? You may not realize that you're in trouble until checks start bouncing and your bona fide charges are refused at the checkout lane. By then, your bank account could be empty and your overdraft protection entirely burned up. And all the legitimate checks and electronic payments you tried to send will bounce.
It could take the bank as many as 10 days to restore the funds to your bank account (because they'll want to investigate and make sure your claim of unauthorized use of the card is accurate). Unless you have a second bank account somewhere (preferably at a different bank for the sake of safety), you will have no cash, as in zero, zip, nada. And if this is a joint bank account for you and your spouse, you could be looking at a night or two on the living room couch.
Then, there's the question of all those checks and electronic payments that are bouncing. Maybe the bank will restore your funds eventually. But what about all the fees that other people are charging you for bouncing a check, or being late in making payment? You'll be late because you have to get them to resubmit the check to the bank after your account is restored, or because you'll have to resend the electronic payment after there's some money in the account to send. Ideally, everyone will be nice to you and not impose these fees. But you'll have to do a lot of explaining, and maybe a little begging and pleading.
With a credit card, your cash remains untouched, your legitimate checks and electronic payments won't bounce, and you're liable for $50 max. Yes, you'll have to contact the credit card company, and the sooner the better. But your worst case scenario is an argument with them about whether you owe them $50 or not, and many won't even hassle you over that.
Ultimately, the choice of credit or debit is a matter of personal preference. But if you prefer debit, be very, very careful with the card. Don't let others see your PIN. Don't use the card for Internet purchases. And keep track of your bank account balance. With a credit card, you have to rely on something else to control your spending besides the purchasing power of the card.
With either kind of card, you have to look over your monthly account statements carefully. These days, you never know if your card number has been stolen and a few charges quietly slipped onto your
account. A clever crook might do that to reduce the chances of detection. If you're not careful, you could be stuck with those charges, not because you'd necessarily be required to pay them but because you simply didn't notice them.
For more personal finance ideas, go to http://howtomakeamilliondollars.blogspot.com/2007/09/festival-of-under-30-finances.html.
Crime News: Stolen Homer Simpson statue recovered. http://www.wtop.com/?nid=456&sid=1171977. Whew. We're so relieved.
Wednesday, June 20, 2007
Investing in Individual Stocks and Bonds
Back in the days when cars had fins and a household felt lucky to have one television, people invested mostly by buying individual stocks and bonds. The market swung up and down in the 1950's and 1960's, and then really dipped in the 1970's. After that, the benefits of diversification became much more apparent, and investors have gravitated toward mutual funds, and now their latest iteration, ETFs. But what about investing in individual stocks and bonds? Is it a workable way to invest? Is it a good idea? Here are a few thoughts.
1. It'll take a lot of research and analysis. You'll have to look into a number of potential investments before you find a good one. And you'll need a number of good ones to have a reasonably diversified portfolio. Don't invest based solely on someone's recommendation, especially if you got it in a social setting. Would you take financial advice from a financial planner who's had a couple of drinks? If not, why would you take financial advice from an acquaintance or neighbor who's had a couple of drinks? People will boast about their winners, but you won't hear much about their losers. So you'll get only half the story.
2. You'll have the problem of too much choice. There are thousands of mutual funds and ETFs to choose from. There are many, many more individual stocks and bonds. Knowing where to begin your research, and where to stop, will be a challenge. Sure, the Internet provides you a lot of information. But it provides everyone a lot of information. You'll have no informational advantage from using the Internet. You may be thinking that if you had been an early investor in Microsoft or Berkshire Hathaway, you'd be trading up to a bigger yacht today. But which of the many thousands of stocks available today is the next Microsoft or Berkshire Hathaway?
3. You need to keep a lot of records. In order to do your tax returns correctly, you'll have to have a detailed history of the stocks you own. Of course, you need a record of how much you paid for it--and it has to be a good record, like an account statement or a trade confirmation. Your personal notes or your entry in some computer software won't carry a lot of weight with the IRS. And that's just the beginning. You'll need to keep track of stock splits and stock swaps resulting from mergers or corporate recapitalizations. If you participate in a dividend reinvestment program, keeping track of the tax basis in your shares becomes more complex. And if you inherit stock, you need to know the "carry over" basis in the stock (i.e.., its value on the date of death of the person who bequeathed the stock to you). Get used to the idea of keeping some paper records for a very long time, because many computerized records often don't have much legal value as evidence. Further, as computer storage technology changes over time, the data on those floppy disks in the back of your desk will be inaccessible soon, if they aren't already.
4. You still have to diversify, but diversification is much harder with individual stocks and bonds. You need a fair amount of capital to have reasonable diversification, with stockholdings across a number of different industry groups, and in foreign as well as American companies. You'll also need to have some bonds, and the bond part of your portfolio should have a variety of maturities, ranging from at least two to ten years.
5. Unlike mutual fund investments, you'd have to pay commissions to purchase stocks, and also the "bid-ask spread." Stocks are quoted in two prices in the stock market: (a) the "ask" price, at which you buy; and (b) the "bid" price, at which you sell. The difference between these two prices, called the "bid-ask spread" is tantamount to an expense of investing. If you invest for the long term, buying and holding stocks for years or decades, these costs tend to amortize over a long time and become fairly minor. But if you trade stocks a lot, these costs can significantly reduce your returns.
6. You'll face the temptation to trade stocks and bonds on a short term basis, selling whenever you have a bit of a profit. This is a bad idea, because short term trading generally is less profitable than buying and holding. But your stock broker may encourage short term trading because it generates commission income for him or her.
7. At the same time, you have to monitor your portfolio and sell the investments that seem to be going downhill. The value of stocks can sometimes evaporate very quickly. Ask Enron shareholders about this.
8. If you see finance as a hobby or avocation, and are willing to put a lot of time into it, investing in individual stocks and bonds may be enjoyable and profitable. But if all this investing stuff is just work and more work for you, stick with mutual funds and ETFs.
Crime News: what some people will do to get their fruits and vegetables. http://www.wtop.com/?nid=456&sid=1170738.
1. It'll take a lot of research and analysis. You'll have to look into a number of potential investments before you find a good one. And you'll need a number of good ones to have a reasonably diversified portfolio. Don't invest based solely on someone's recommendation, especially if you got it in a social setting. Would you take financial advice from a financial planner who's had a couple of drinks? If not, why would you take financial advice from an acquaintance or neighbor who's had a couple of drinks? People will boast about their winners, but you won't hear much about their losers. So you'll get only half the story.
2. You'll have the problem of too much choice. There are thousands of mutual funds and ETFs to choose from. There are many, many more individual stocks and bonds. Knowing where to begin your research, and where to stop, will be a challenge. Sure, the Internet provides you a lot of information. But it provides everyone a lot of information. You'll have no informational advantage from using the Internet. You may be thinking that if you had been an early investor in Microsoft or Berkshire Hathaway, you'd be trading up to a bigger yacht today. But which of the many thousands of stocks available today is the next Microsoft or Berkshire Hathaway?
3. You need to keep a lot of records. In order to do your tax returns correctly, you'll have to have a detailed history of the stocks you own. Of course, you need a record of how much you paid for it--and it has to be a good record, like an account statement or a trade confirmation. Your personal notes or your entry in some computer software won't carry a lot of weight with the IRS. And that's just the beginning. You'll need to keep track of stock splits and stock swaps resulting from mergers or corporate recapitalizations. If you participate in a dividend reinvestment program, keeping track of the tax basis in your shares becomes more complex. And if you inherit stock, you need to know the "carry over" basis in the stock (i.e.., its value on the date of death of the person who bequeathed the stock to you). Get used to the idea of keeping some paper records for a very long time, because many computerized records often don't have much legal value as evidence. Further, as computer storage technology changes over time, the data on those floppy disks in the back of your desk will be inaccessible soon, if they aren't already.
4. You still have to diversify, but diversification is much harder with individual stocks and bonds. You need a fair amount of capital to have reasonable diversification, with stockholdings across a number of different industry groups, and in foreign as well as American companies. You'll also need to have some bonds, and the bond part of your portfolio should have a variety of maturities, ranging from at least two to ten years.
5. Unlike mutual fund investments, you'd have to pay commissions to purchase stocks, and also the "bid-ask spread." Stocks are quoted in two prices in the stock market: (a) the "ask" price, at which you buy; and (b) the "bid" price, at which you sell. The difference between these two prices, called the "bid-ask spread" is tantamount to an expense of investing. If you invest for the long term, buying and holding stocks for years or decades, these costs tend to amortize over a long time and become fairly minor. But if you trade stocks a lot, these costs can significantly reduce your returns.
6. You'll face the temptation to trade stocks and bonds on a short term basis, selling whenever you have a bit of a profit. This is a bad idea, because short term trading generally is less profitable than buying and holding. But your stock broker may encourage short term trading because it generates commission income for him or her.
7. At the same time, you have to monitor your portfolio and sell the investments that seem to be going downhill. The value of stocks can sometimes evaporate very quickly. Ask Enron shareholders about this.
8. If you see finance as a hobby or avocation, and are willing to put a lot of time into it, investing in individual stocks and bonds may be enjoyable and profitable. But if all this investing stuff is just work and more work for you, stick with mutual funds and ETFs.
Crime News: what some people will do to get their fruits and vegetables. http://www.wtop.com/?nid=456&sid=1170738.
Tuesday, June 19, 2007
Annuities
The nice thing about pensions is that you know what you are going to get and when you’ll get it. Anyone who has experienced the stock markets bouncing up and down, and then lived through the real estate roller coaster knows that economic certainty is about as easy to find as Nessie. With traditional pension plans going the way of the dodo, what certainty for retirement is there?
There’s Social Security. Hahahahahahahahaha. Okay, now that we’ve had our little laugh, let’s be serious for a moment. Social Security isn’t going to disappear. It may not be as generous in the future as it is now, but it will be there in some form when you retire. How can we be sure? Because no politician in Washington will let it die for fear of losing his or her job. Congress is one of the few places where you get paid well over 100K a year to talk all day without having to do anything. Very few members want to give up a job like that.
But is there any other certainty? One thing that the insurance industry is promoting is the idea of an annuity. There are about as many different types of annuities as there are types of cars, and we will focus today on the ones that supposedly provide certainty: the lump sum immediate fixed annuity and the lump sum immediate inflation-adjusted annuity.
The lump sum immediate fixed annuity is simple in concept. You pay an insurance company some money and the company agrees to pay you a fixed monthly payment for life. The time period of payments can also be limited, such as for ten or twenty years, but an annuity usually makes the most sense if you get the promise of payments for life. The amount of the monthly payment will vary depending on the amount you invest, interest rates, your age and gender, the fees and charges of the insurance company, and perhaps other factors.
There are also inflation adjusted annuities, where the amount you get will start off lower than it would for a fixed annuity. However, it will be increased in line with inflation, so over the long run, you may feel more secure. It may start out with payments that are 25% to 30% lower than fixed annuities, but depending on inflation could end up much higher.
One of the tradeoffs with these annuities is that you lose access to the principal you invest in them. In other words, if you spend $100K to buy an annuity and die the next day, your heirs are out of luck. They won’t inherit a penny of that 100K. (There are modified annuities that provide for somewhat of an inheritance, but it costs you in terms of reduced monthly payments and the inheritance feature will usually expire after a few years.)
Is it worthwhile to buy an annuity?
First, you need to have some real cash. Insurance companies like customers who can throw 100K, 200K or more at these things. If you’re going into retirement with a house, 50K or 75K in savings and Social Security, don’t bother with an annuity.
Second, if you have the money, don’t spend more than half of your financial assets on an annuity. You may have serious cash needs in retirement—assisted living facilities are not covered by Medicare or Medicaid. And other health care expenses may also not be insured. You can’t retrieve the cash in the annuity, so you’d better keep a good sized bundle on hand. Invest your remaining assets in a diversified portfolio with some stock market exposure, as a hedge against inflation.
Third, if you have Social Security and a pension, you probably don’t need an annuity. Between Social Security and the pension, much of your finances are already annuitized. Keep your financial assets for the major cash needs that may arise. Invest them in a diversified portfolio with some exposure to stocks to provide a hedge against inflation.
Fourth, think about whether an annuity might help you control your spending. If you’re likely to spend down your savings rather quickly, annuitizing part of them might help you make your money last through retirement. You could look to the annuity payment, plus Social Security, to cover your ordinary living expenses. An annuity may not be a great investment (usually, they’re not because the fees and charges are rather high). But if the steady payments from an annuity would give you a psychological boost and keep you from spending down the rest of your savings quickly, then it might be a good idea.
Remember that annuities are subject to the risk that the insurance company may fail, and be unable to pay its obligations. Research the creditworthiness of the insurance company before buying.
Crime News: the British police don’t carry guns, but they ride in pedicabs. http://www.wtop.com/?nid=456&sid=1167116.
There’s Social Security. Hahahahahahahahaha. Okay, now that we’ve had our little laugh, let’s be serious for a moment. Social Security isn’t going to disappear. It may not be as generous in the future as it is now, but it will be there in some form when you retire. How can we be sure? Because no politician in Washington will let it die for fear of losing his or her job. Congress is one of the few places where you get paid well over 100K a year to talk all day without having to do anything. Very few members want to give up a job like that.
But is there any other certainty? One thing that the insurance industry is promoting is the idea of an annuity. There are about as many different types of annuities as there are types of cars, and we will focus today on the ones that supposedly provide certainty: the lump sum immediate fixed annuity and the lump sum immediate inflation-adjusted annuity.
The lump sum immediate fixed annuity is simple in concept. You pay an insurance company some money and the company agrees to pay you a fixed monthly payment for life. The time period of payments can also be limited, such as for ten or twenty years, but an annuity usually makes the most sense if you get the promise of payments for life. The amount of the monthly payment will vary depending on the amount you invest, interest rates, your age and gender, the fees and charges of the insurance company, and perhaps other factors.
There are also inflation adjusted annuities, where the amount you get will start off lower than it would for a fixed annuity. However, it will be increased in line with inflation, so over the long run, you may feel more secure. It may start out with payments that are 25% to 30% lower than fixed annuities, but depending on inflation could end up much higher.
One of the tradeoffs with these annuities is that you lose access to the principal you invest in them. In other words, if you spend $100K to buy an annuity and die the next day, your heirs are out of luck. They won’t inherit a penny of that 100K. (There are modified annuities that provide for somewhat of an inheritance, but it costs you in terms of reduced monthly payments and the inheritance feature will usually expire after a few years.)
Is it worthwhile to buy an annuity?
First, you need to have some real cash. Insurance companies like customers who can throw 100K, 200K or more at these things. If you’re going into retirement with a house, 50K or 75K in savings and Social Security, don’t bother with an annuity.
Second, if you have the money, don’t spend more than half of your financial assets on an annuity. You may have serious cash needs in retirement—assisted living facilities are not covered by Medicare or Medicaid. And other health care expenses may also not be insured. You can’t retrieve the cash in the annuity, so you’d better keep a good sized bundle on hand. Invest your remaining assets in a diversified portfolio with some stock market exposure, as a hedge against inflation.
Third, if you have Social Security and a pension, you probably don’t need an annuity. Between Social Security and the pension, much of your finances are already annuitized. Keep your financial assets for the major cash needs that may arise. Invest them in a diversified portfolio with some exposure to stocks to provide a hedge against inflation.
Fourth, think about whether an annuity might help you control your spending. If you’re likely to spend down your savings rather quickly, annuitizing part of them might help you make your money last through retirement. You could look to the annuity payment, plus Social Security, to cover your ordinary living expenses. An annuity may not be a great investment (usually, they’re not because the fees and charges are rather high). But if the steady payments from an annuity would give you a psychological boost and keep you from spending down the rest of your savings quickly, then it might be a good idea.
Remember that annuities are subject to the risk that the insurance company may fail, and be unable to pay its obligations. Research the creditworthiness of the insurance company before buying.
Crime News: the British police don’t carry guns, but they ride in pedicabs. http://www.wtop.com/?nid=456&sid=1167116.
Sunday, June 17, 2007
Reverse Mortgages
Jan. 21, 2011 Update: the FHA has recently announced a "Saver" reverse mortgage, which offers lower fees than traditional FHA guaranteed mortgages (around 40% lower). But you cannot borrow as much under a Saver as you can under a traditional reverse mortgage. At interest rates available in early 2011, you can borrow about 50% of the value of the home with a Saver, compared to 60% to 65% with a traditional FHA guaranteed reverse mortgage. And the interest rate on the Saver may be a little higher than on a traditional loan. The Saver isn't for everyone, but those who need to borrow less (and/or their heirs) may end up better off with a Saver.
Original Blog:
Many, and perhaps most Americans, enter retirement with a modest amount of savings and a house. They have Social Security, and if they're lucky, a pension. Social Security payments are increased for inflation, but most pensions are not. Money may eventually get tight. The cost of living goes only in one direction, and it isn't down. Property taxes increase over time. And medical expenses rise as one grows older. If there isn't a large pool of savings to tap into, what does a retiree do, especially one that still wants to live at home?
Increasingly, retirees have been taking out reverse mortgages. A reverse mortgage is a way for a person who is at least 62 to take the equity out of his or her home, with a unique feature. The homeowner doesn't have to make any payments until he or she leaves the house permanently (e.g., to move to an assisted living facility), sells the house, or passes away. This is a very convenient arrangement for a person without much savings or income. The homeowner can get a lump sum, a line of credit or regular monthly payments.
There must be a catch, you say. And if you said that, you'd be right. Reverse mortgages are a very expensive way to borrow. Part of the problem is the deferral of repayment. Since the homeowner doesn't have to repay the loan for years, or potentially even decades, the interest on the loan will accrue unpaid for a long time and will have to come from the value of the house. The longer the homeowner's life expectancy, the less he or she will be able to borrow. That's because much and even most of the home's value has to be set aside for interest payments. With the best kind of reverse mortgage available, the "home equity conversion mortgage" (HECM), a homeowner at age 62 can borrow around half the value of the house at current interest rates. The older you get, the more you can borrow because your shorter life expectancy means a smaller amount of interest will accrue.
Reverse mortgages also have very high closing costs, potentially as much as 10% or more of the value of the loan. The charges include an origination fee, a mortgage insurance fee, and various closing costs. Fees this large can significantly increase the effective cost of borrowing.
Another consideration is that the cost of repaying a reverse mortgage could consume virtually the entire value of the house. If the homeowner wanted to leave the house behind as an inheritance, a reverse mortgage pretty much switches the inheritance over to the bank.
Americans, on the whole, are lousy savers. They do like to own their homes, however, and will often do whatever they can to own the old homestead by the time they get the retirement watch. With a cash-poor, house-rich retired population, it's no wonder the reverse mortgage has grown in popularity. And with the Baby Boom generation closing in on its golden years, there's no reason to think this trend will change.
Needless to say, the financial services industry hasn't overlooked reverse mortgages. More and more financial institutions are offering them, and there are some indications that the fees may be diminishing a bit. In fact, people with second homes may soon be able to get reverse mortgages on them. Many seniors are targeted by mass mailings touting reverse mortgages.
It's important to be very careful with a reverse mortgage. The math is quite a bit more complex than a traditional mortgage's math (and that's not necessarily simple). Older folks may not understand all of the nuances of the transaction. The elderly make easy targets for fast-talking sales people. In the worse case scenarios, they may be persuaded to take out a reverse mortgage and invest the money in an annuity or other financial product that pays the sales person a juicy commission. That is a bad financial move, but some unscrupulous sales people evidently have done this.
Elderly people may also get less legal protection. They can have wobbly recollections. They sometimes develop mental impairments, and cannot testify. And they might even pass away before the bad guys can be successfully prosecuted. That's why crooks love to prey on them.
If you're thinking of taking out a reverse mortgage, you'll be required to get financial counseling first. Listen closely to the counselor--he or she may have suggestions for other ways for you to deal with your financial problems. Also, talk to your family and friends. You don't want your only source of information to be a sales person.
If it's your parent, or grandparent, who is thinking of getting a reverse mortgage, be willing to help out. Maybe, even offer to help out. It's always difficult for a younger generation to involve itself in an older generation's finances. But you can be respectful and helpful at the same time. Deal with your elder the way you'd like dealt with when you're the elder. A reverse mortgage may be a very good idea, or a very bad one, and you can help out either way.
Strange News: another guy gets his 15 minutes of fame. http://www.wtop.com/?nid=456&sid=1168649.
Original Blog:
Many, and perhaps most Americans, enter retirement with a modest amount of savings and a house. They have Social Security, and if they're lucky, a pension. Social Security payments are increased for inflation, but most pensions are not. Money may eventually get tight. The cost of living goes only in one direction, and it isn't down. Property taxes increase over time. And medical expenses rise as one grows older. If there isn't a large pool of savings to tap into, what does a retiree do, especially one that still wants to live at home?
Increasingly, retirees have been taking out reverse mortgages. A reverse mortgage is a way for a person who is at least 62 to take the equity out of his or her home, with a unique feature. The homeowner doesn't have to make any payments until he or she leaves the house permanently (e.g., to move to an assisted living facility), sells the house, or passes away. This is a very convenient arrangement for a person without much savings or income. The homeowner can get a lump sum, a line of credit or regular monthly payments.
There must be a catch, you say. And if you said that, you'd be right. Reverse mortgages are a very expensive way to borrow. Part of the problem is the deferral of repayment. Since the homeowner doesn't have to repay the loan for years, or potentially even decades, the interest on the loan will accrue unpaid for a long time and will have to come from the value of the house. The longer the homeowner's life expectancy, the less he or she will be able to borrow. That's because much and even most of the home's value has to be set aside for interest payments. With the best kind of reverse mortgage available, the "home equity conversion mortgage" (HECM), a homeowner at age 62 can borrow around half the value of the house at current interest rates. The older you get, the more you can borrow because your shorter life expectancy means a smaller amount of interest will accrue.
Reverse mortgages also have very high closing costs, potentially as much as 10% or more of the value of the loan. The charges include an origination fee, a mortgage insurance fee, and various closing costs. Fees this large can significantly increase the effective cost of borrowing.
Another consideration is that the cost of repaying a reverse mortgage could consume virtually the entire value of the house. If the homeowner wanted to leave the house behind as an inheritance, a reverse mortgage pretty much switches the inheritance over to the bank.
Americans, on the whole, are lousy savers. They do like to own their homes, however, and will often do whatever they can to own the old homestead by the time they get the retirement watch. With a cash-poor, house-rich retired population, it's no wonder the reverse mortgage has grown in popularity. And with the Baby Boom generation closing in on its golden years, there's no reason to think this trend will change.
Needless to say, the financial services industry hasn't overlooked reverse mortgages. More and more financial institutions are offering them, and there are some indications that the fees may be diminishing a bit. In fact, people with second homes may soon be able to get reverse mortgages on them. Many seniors are targeted by mass mailings touting reverse mortgages.
It's important to be very careful with a reverse mortgage. The math is quite a bit more complex than a traditional mortgage's math (and that's not necessarily simple). Older folks may not understand all of the nuances of the transaction. The elderly make easy targets for fast-talking sales people. In the worse case scenarios, they may be persuaded to take out a reverse mortgage and invest the money in an annuity or other financial product that pays the sales person a juicy commission. That is a bad financial move, but some unscrupulous sales people evidently have done this.
Elderly people may also get less legal protection. They can have wobbly recollections. They sometimes develop mental impairments, and cannot testify. And they might even pass away before the bad guys can be successfully prosecuted. That's why crooks love to prey on them.
If you're thinking of taking out a reverse mortgage, you'll be required to get financial counseling first. Listen closely to the counselor--he or she may have suggestions for other ways for you to deal with your financial problems. Also, talk to your family and friends. You don't want your only source of information to be a sales person.
If it's your parent, or grandparent, who is thinking of getting a reverse mortgage, be willing to help out. Maybe, even offer to help out. It's always difficult for a younger generation to involve itself in an older generation's finances. But you can be respectful and helpful at the same time. Deal with your elder the way you'd like dealt with when you're the elder. A reverse mortgage may be a very good idea, or a very bad one, and you can help out either way.
Strange News: another guy gets his 15 minutes of fame. http://www.wtop.com/?nid=456&sid=1168649.
Friday, June 15, 2007
529 College Savings Plan Alert
You've probably heard of the 529 College Savings Plan. It's a program, usually sponsored by a state, that allows you to open an account and save on a tax advantaged basis for college expenses. There are dozens of 529 Plans to choose from, and no two plans are alike. A parent, grandparent, aunt or uncle trying to walk through the thicket of 529 plans could easily become confused and feel lost. They might naturally look for help.
Many 529 plans are sold by stock brokers. It may seem easier to ask a financial professional which of the confusing array of 529 plans is best. That certainly takes less time than wading through the details of even a couple of 529 plans. But stock brokers don't work for free. They work for commissions, and if they persuade you to open an account with a particular 529 Plan, you can be pretty certain they get a commission from it. If fact, they may have disclosed that commission to you. (If they didn't, ask.)
But there's a cloud on the horizon. The SEC (U.S. Securities and Exchange Commission), which regulates stock brokers, posted a "compliance alert" on its website on June 14, 2007: (http://www.sec.gov/about/offices/ocie/complialert.htm). The alert says that the SEC staff has uncovered problems with the way that brokerage firms supervise the sale of 529 plans. (You have to scroll about two-thirds of the way through the alert to get to the part about 529 plans.)
Brokerage firms have a legal duty to supervise their sales people (i.e., their brokers). The SEC staff has learned that many brokerage firms lack adequate processes and procedures to supervise the sale of 529 plans. That's not good, because 529 plans are hot ticket items these days, with the cost of college educations rising faster than the rate of inflation.
The SEC reported that one problem was a lack of evidence that brokerage firms were reviewing 529 sales to see that they were suitable for the customers. Brokers are supposed to recommend only investments and financial products that are "suitable" for their customers. Suitability is one of the crucial protections you, as an investor, have. Brokers should focus on your individual needs and wants. For example, if you and your spouse are in your 20's and have a one-year old child, the type of investments you'd use for college savings would probably be more heavily weighted towards stocks and their potential for long term growth, because the child has 17 years to go before college and the stock market may offer good returns over a long period of time like that. But if you and your spouse are north of the big 5-0 and the baby of the family is entering college in two years, you'd want to ratchet down the risk levels of your college savings so that you'd have less chance of losing entire tuition payments in the stock market because a big hedge fund has a tummy ache. If the brokerage firms aren't adequately supervising for suitability, there's a greater risk you might end up with a 529 plan that isn't right for you.
The SEC's compliance alert also revealed that, at many brokerage firms, 529 plan transactions were not entered into the firm's computer records. Why does recordkeeping matter? Because it is one of the keys to effective supervision. If a supervisor can't learn about a sale to a customer, how can the supervisors supervise? A supervisor could be responsible for numerous brokers and can't watch all of them every minute. So the supervisor has to rely on records much of the time. Without good recordkeeping, there may not be effective supervision and that heightens the risk of unsuitable sales of 529 plans.
The SEC also expressed concern that many brokerage firms didn't train supervisors or brokers adequately about the suitability of 529 plans the firms were recommending. This makes us furrow our brows more deeply.
Does the compliance alert mean that a 529 plan account that you opened through a stock broker is wrong for you? Not necessarily. Does it mean that your stock broker cheated you? Not necessarily. But it means that circumstances may have made it easier for a naughty stock broker to deal unfairly with you. Review your plan closely and see if it really suits your needs and wants. Think about whether you're comfortable with the risk levels of the investments in the plan. Look at the fees and expenses of the plan. Are they 2% or 3% a year? If so, that's pretty steep. Less expensive 529 plans are readily available. The plans with high fees and expenses may also be the ones that pay brokers generous commissions. If you have an expensive plan, you'd have to consider whether the broker might have put you in that plan in order to get a juicy commission.
If you're going to talk to a broker about 529 plans, be careful. Do your homework first. Learn as much as you can about these plans before you talk to the broker. Sure, the broker is supposed to be the expert. But the broker is also a salesperson. Would you rely on a salesperson at a car dealership to choose the best vehicle for you? No. You'd study up on cars first and have an idea of what you really want. Buying a 529 plan, which can involve a lot of money, deserves your time and attention, before you meet with the salesperson.
For more information about saving for college, please go to our earlier blog at http://blogger.uncleleosden.com/2007/05/downsides-of-saving-for-college.html.
Celebrity News: Guess who was once a cheerleader (it's weirder than you'd think): http://www.nbc4.com/slideshow/entertainment/13010870/detail.html.
Many 529 plans are sold by stock brokers. It may seem easier to ask a financial professional which of the confusing array of 529 plans is best. That certainly takes less time than wading through the details of even a couple of 529 plans. But stock brokers don't work for free. They work for commissions, and if they persuade you to open an account with a particular 529 Plan, you can be pretty certain they get a commission from it. If fact, they may have disclosed that commission to you. (If they didn't, ask.)
But there's a cloud on the horizon. The SEC (U.S. Securities and Exchange Commission), which regulates stock brokers, posted a "compliance alert" on its website on June 14, 2007: (http://www.sec.gov/about/offices/ocie/complialert.htm). The alert says that the SEC staff has uncovered problems with the way that brokerage firms supervise the sale of 529 plans. (You have to scroll about two-thirds of the way through the alert to get to the part about 529 plans.)
Brokerage firms have a legal duty to supervise their sales people (i.e., their brokers). The SEC staff has learned that many brokerage firms lack adequate processes and procedures to supervise the sale of 529 plans. That's not good, because 529 plans are hot ticket items these days, with the cost of college educations rising faster than the rate of inflation.
The SEC reported that one problem was a lack of evidence that brokerage firms were reviewing 529 sales to see that they were suitable for the customers. Brokers are supposed to recommend only investments and financial products that are "suitable" for their customers. Suitability is one of the crucial protections you, as an investor, have. Brokers should focus on your individual needs and wants. For example, if you and your spouse are in your 20's and have a one-year old child, the type of investments you'd use for college savings would probably be more heavily weighted towards stocks and their potential for long term growth, because the child has 17 years to go before college and the stock market may offer good returns over a long period of time like that. But if you and your spouse are north of the big 5-0 and the baby of the family is entering college in two years, you'd want to ratchet down the risk levels of your college savings so that you'd have less chance of losing entire tuition payments in the stock market because a big hedge fund has a tummy ache. If the brokerage firms aren't adequately supervising for suitability, there's a greater risk you might end up with a 529 plan that isn't right for you.
The SEC's compliance alert also revealed that, at many brokerage firms, 529 plan transactions were not entered into the firm's computer records. Why does recordkeeping matter? Because it is one of the keys to effective supervision. If a supervisor can't learn about a sale to a customer, how can the supervisors supervise? A supervisor could be responsible for numerous brokers and can't watch all of them every minute. So the supervisor has to rely on records much of the time. Without good recordkeeping, there may not be effective supervision and that heightens the risk of unsuitable sales of 529 plans.
The SEC also expressed concern that many brokerage firms didn't train supervisors or brokers adequately about the suitability of 529 plans the firms were recommending. This makes us furrow our brows more deeply.
Does the compliance alert mean that a 529 plan account that you opened through a stock broker is wrong for you? Not necessarily. Does it mean that your stock broker cheated you? Not necessarily. But it means that circumstances may have made it easier for a naughty stock broker to deal unfairly with you. Review your plan closely and see if it really suits your needs and wants. Think about whether you're comfortable with the risk levels of the investments in the plan. Look at the fees and expenses of the plan. Are they 2% or 3% a year? If so, that's pretty steep. Less expensive 529 plans are readily available. The plans with high fees and expenses may also be the ones that pay brokers generous commissions. If you have an expensive plan, you'd have to consider whether the broker might have put you in that plan in order to get a juicy commission.
If you're going to talk to a broker about 529 plans, be careful. Do your homework first. Learn as much as you can about these plans before you talk to the broker. Sure, the broker is supposed to be the expert. But the broker is also a salesperson. Would you rely on a salesperson at a car dealership to choose the best vehicle for you? No. You'd study up on cars first and have an idea of what you really want. Buying a 529 plan, which can involve a lot of money, deserves your time and attention, before you meet with the salesperson.
For more information about saving for college, please go to our earlier blog at http://blogger.uncleleosden.com/2007/05/downsides-of-saving-for-college.html.
Celebrity News: Guess who was once a cheerleader (it's weirder than you'd think): http://www.nbc4.com/slideshow/entertainment/13010870/detail.html.
Thursday, June 14, 2007
Health Savings Plans
One of the most heavily promoted new health insurance products is the health savings plan. It's becoming increasingly popular with employers because it costs them less. That's nice for them, but what about the employees and their families (also known as the "patients")? Is a health savings plan good for them?
First, let's look at the basic features of this plan. It combines a high deductible health insurance policy with a tax advantaged savings account. The patients are expected to pay the first few thousands of dollars of health care expenses they have each year. They save pretax dollars in the health savings account (as much as $2,850 for individuals and $5650 for families). If the account is part of an employer-sponsored plan, the employer may contribute money to the account as well. The account is portable--if the employee changes jobs, he or she can take the account along (including the employer contributions). Your health savings account may be invested in stocks, bonds or mutual funds. Otherwise, the money will usually be put into a bank account that pays relatively low interest.
You can pay medical expenses out of account. In effect, you'd be paying your health expenses with pretax dollars. But you don't have to pay medical expenses from the account. You can save it for future medical expenses, and build up the amount of the fund with future contributions.
As for the insurance part of the plan, that's where the high deductible insurance plan comes into the picture. After you pay a substantial deductible (which can be thousands), the insurance plan begins to pay. Some high deductible plans pay all expenses (i.e., there's no copay). Others require a copay.
The theory behind these plans is that by requiring patients to pay the initial few thousands up front, the plan motivates them to seek out lower cost providers and use their health dollars more efficiently. Supposedly, less money is wasted on needless or high-cost health care. For example, patients might choose an inexpensive generic prescription drug rather than an expensive name brand. The employers benefit because the premiums are lower.
Consumer advocates have complained that health savings plans are difficult for consumers to use because price-shopping for health care is difficult. It you have a broken wrist, you head for the first available emergency room. You don't call several hospitals and ask them to fax you their price lists. If you're diagnosed with cancer, you look for the best physician you can find, not the cheapest. Few patients have the medical sophistication to decide whether or not they need a CT scan, an MRI, an ultrasound, or some combination of the three. Patients required to pay full freight may defer health care when they initially have a problem, and then seek help only when it's gotten worse--and probably more expensive to treat.
If your employer switches totally to a health savings plan, you don't have any choice but to open an account. Do so because it gives you a tax advantage.
If you have a choice, a health savings account is a good idea if you are quite healthy. That means most younger people are more likely to benefit. But some young people have significant health problems and some older people are quite healthy, so focus on your personal situation. If you don't need a lot of health care, the money in the account can accumulate and compound into a nice medical care nest egg for the future.
If you need a fair amount of health care, a health savings account may do little or nothing to make you better off. Indeed, you may be better off with a traditional plan. Remember that with a high deductible health plan, you might have to pay full freight for the first few thousand dollars. That means that a prescription that you're used to getting for a $20 copay may end up costing you $100 because you don't get the subsidized price you used to get. One advantage of traditional plans is that professional plan administrators are bargaining with the pharmaceutical companies for discounts. With a high deductible plan, you could be on your own.
A recent study by the Georgetown University Health Policy Institute and the Kaiser Family Foundation found that in most pregnancies, a traditional health care plan appeared to be less costly than high deductible plans. For copies of this report, go to http://www.kff.org/womenshealth/7636.cfm. This is an example of how people who need significant health care often appear to be better off with traditional health insurance.
A person who is well off (annual income of $100,000 or more a year) and needs relatively little health care has a nice little investment gambit with health savings accounts. Stuff as much money in the account as you can, pay for your current medical expenses with aftertax dollars, and let the account balance build up. The money can always be used tax free for medical expenses. After you reach age 65, the money can be withdrawn for nonmedical purposes and all you need to do is pay state and federal income taxes (in other words, it's just like a traditional IRA or 401(k) account). If you withdraw the money before age 65 for a nonmedical purpose, you have to pay income taxes and a 10% penalty. Just beware of one thing: you won't always be healthy. Everyone suffers some deterioration in health eventually. Or they are hurt in a car accident. If that happens to you while you have a high deductible plan, your financial success may not glow as brightly.
Okay, so a health savings account will help the well-off become more well-off. How about everyone else? If your employer gives you a choice between a traditional plan and a high deductible plan, be very careful. Parents should keep in mind the substantial health care costs that kids sometimes have. People with ordinary or less than ordinary health should avoid creating disincentives to seek care. Many medical problems can be addressed fairly easily if you get to a doctor quickly. Wait a while, though, and you could be in big trouble.
The bottom line is that when you're thinking about health insurance, focus on the insurance part of it. Health savings plans tend to confuse things, because they mix investment with insurance. You might make a bad choice because you're trying to resolve too many conflicting considerations. Look at things from the standpoint of which plan gives you the best health insurance coverage. When you or your child is diagnosed with leukemia, you won't give a rat's left ear about investment options or tax advantages. All you'll want is the most comprehensive health insurance coverage possible, something that covers all possible treatments from sunup to sundown. Some high deductible plans are improving the scope and extent of their health insurance coverage, and maybe in the end, they will seem like the best option. But whether the best option is a traditional plan or a high deductible plan, make sure you're buying health insurance when you're considering health insurance plans. You've got 401(k)s, IRAs, mutual funds and plenty of other means to handle your investment needs.
Health News: To lose weight, turn up the lights. http://www.nbc4.com/family/13447047/detail.html.
First, let's look at the basic features of this plan. It combines a high deductible health insurance policy with a tax advantaged savings account. The patients are expected to pay the first few thousands of dollars of health care expenses they have each year. They save pretax dollars in the health savings account (as much as $2,850 for individuals and $5650 for families). If the account is part of an employer-sponsored plan, the employer may contribute money to the account as well. The account is portable--if the employee changes jobs, he or she can take the account along (including the employer contributions). Your health savings account may be invested in stocks, bonds or mutual funds. Otherwise, the money will usually be put into a bank account that pays relatively low interest.
You can pay medical expenses out of account. In effect, you'd be paying your health expenses with pretax dollars. But you don't have to pay medical expenses from the account. You can save it for future medical expenses, and build up the amount of the fund with future contributions.
As for the insurance part of the plan, that's where the high deductible insurance plan comes into the picture. After you pay a substantial deductible (which can be thousands), the insurance plan begins to pay. Some high deductible plans pay all expenses (i.e., there's no copay). Others require a copay.
The theory behind these plans is that by requiring patients to pay the initial few thousands up front, the plan motivates them to seek out lower cost providers and use their health dollars more efficiently. Supposedly, less money is wasted on needless or high-cost health care. For example, patients might choose an inexpensive generic prescription drug rather than an expensive name brand. The employers benefit because the premiums are lower.
Consumer advocates have complained that health savings plans are difficult for consumers to use because price-shopping for health care is difficult. It you have a broken wrist, you head for the first available emergency room. You don't call several hospitals and ask them to fax you their price lists. If you're diagnosed with cancer, you look for the best physician you can find, not the cheapest. Few patients have the medical sophistication to decide whether or not they need a CT scan, an MRI, an ultrasound, or some combination of the three. Patients required to pay full freight may defer health care when they initially have a problem, and then seek help only when it's gotten worse--and probably more expensive to treat.
If your employer switches totally to a health savings plan, you don't have any choice but to open an account. Do so because it gives you a tax advantage.
If you have a choice, a health savings account is a good idea if you are quite healthy. That means most younger people are more likely to benefit. But some young people have significant health problems and some older people are quite healthy, so focus on your personal situation. If you don't need a lot of health care, the money in the account can accumulate and compound into a nice medical care nest egg for the future.
If you need a fair amount of health care, a health savings account may do little or nothing to make you better off. Indeed, you may be better off with a traditional plan. Remember that with a high deductible health plan, you might have to pay full freight for the first few thousand dollars. That means that a prescription that you're used to getting for a $20 copay may end up costing you $100 because you don't get the subsidized price you used to get. One advantage of traditional plans is that professional plan administrators are bargaining with the pharmaceutical companies for discounts. With a high deductible plan, you could be on your own.
A recent study by the Georgetown University Health Policy Institute and the Kaiser Family Foundation found that in most pregnancies, a traditional health care plan appeared to be less costly than high deductible plans. For copies of this report, go to http://www.kff.org/womenshealth/7636.cfm. This is an example of how people who need significant health care often appear to be better off with traditional health insurance.
A person who is well off (annual income of $100,000 or more a year) and needs relatively little health care has a nice little investment gambit with health savings accounts. Stuff as much money in the account as you can, pay for your current medical expenses with aftertax dollars, and let the account balance build up. The money can always be used tax free for medical expenses. After you reach age 65, the money can be withdrawn for nonmedical purposes and all you need to do is pay state and federal income taxes (in other words, it's just like a traditional IRA or 401(k) account). If you withdraw the money before age 65 for a nonmedical purpose, you have to pay income taxes and a 10% penalty. Just beware of one thing: you won't always be healthy. Everyone suffers some deterioration in health eventually. Or they are hurt in a car accident. If that happens to you while you have a high deductible plan, your financial success may not glow as brightly.
Okay, so a health savings account will help the well-off become more well-off. How about everyone else? If your employer gives you a choice between a traditional plan and a high deductible plan, be very careful. Parents should keep in mind the substantial health care costs that kids sometimes have. People with ordinary or less than ordinary health should avoid creating disincentives to seek care. Many medical problems can be addressed fairly easily if you get to a doctor quickly. Wait a while, though, and you could be in big trouble.
The bottom line is that when you're thinking about health insurance, focus on the insurance part of it. Health savings plans tend to confuse things, because they mix investment with insurance. You might make a bad choice because you're trying to resolve too many conflicting considerations. Look at things from the standpoint of which plan gives you the best health insurance coverage. When you or your child is diagnosed with leukemia, you won't give a rat's left ear about investment options or tax advantages. All you'll want is the most comprehensive health insurance coverage possible, something that covers all possible treatments from sunup to sundown. Some high deductible plans are improving the scope and extent of their health insurance coverage, and maybe in the end, they will seem like the best option. But whether the best option is a traditional plan or a high deductible plan, make sure you're buying health insurance when you're considering health insurance plans. You've got 401(k)s, IRAs, mutual funds and plenty of other means to handle your investment needs.
Health News: To lose weight, turn up the lights. http://www.nbc4.com/family/13447047/detail.html.
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