12b. Create an asset allocation. Part B stable investments

In Part B we will discuss the different types of  "Stable" investments. 

Lets start off with bonds. Bonds are generally less risky than stocks because they have a face value that is guaranteed by the issuer. They are less susceptible to the swings of the stock market and pay out a fixed interest rate that is promised by the issuer. Stocks in comparison can lose all of their face value and dividends can be suspended at will.

Treasuries-
are considered the safest type of bond since they are backed by the full faith and credit of the U.S.government. This safety comes at a price though. You will get some of the lowest interest rates available. They are tax exempt so they are great for non tax sheltered accounts. This year the Treasury will stop selling paper bonds. You can buy them directly from http://www.treasurydirect.gov/ You can also research the different types of bonds available from the Treasury there. I will discuss the different types in more detail in future posts.


State issued bonds-
are different for each state. Usually the state will offer taxable and tax exempt bonds. Every state has there own website for purchasing state bonds. If you live in the State that the bond is issued you will generally not be taxed (Fed. or state). If you live in a state where there is no income tax you can purchase bonds from any state tax free. There  are many variables. So you must do your homework.


Municipal Bonds-
Are issued by a city or other government agency. These can be county's, utilities, school districts, airports etc... As in state issued bonds Municipal bonds are tax free (Fed. and state) as long as you are an in state resident.

Corporate Bonds-
are issued by corporations to expand their business. They are generally more risky than government issued bonds. You need to research companies the same way you would for a stock purchase. They can be a great diversification tool to keep your bonds from all moving together. 


Junk bonds-
Or High yield bonds are below investment grade. Because of their high risk you get a much higher yield. You should never hold more than 5% of these in your portfolio.


International Bonds-
Are debt investments issued by countries outside of the USA and are issued in that countries domestic currency. They are a good way to diversify your bond holdings. They will not move in lock step with the US economy. Pay close attention to the ratings of these types of bonds. Currently Greek and Italian bonds offer high interest rates but are way too risky. A balance of risk and return is key here.


Buying individual bonds is the cheapest way to buy bonds. It is also the most complicated. You need to do your homework for each bond. I do not buy individual bonds yet. I have a full-time job already. When I retire I may dive into that world. Bond funds are much simpler. You can find high quality, low fee bond funds that you can use to diversify. I have four funds I use to mix my bond holdings. A US bond fund, TIPS bond fund, Corporate bond fund, and in an International fund.

Cash - Your liquid savings. This includes Savings accounts, Money markets, and Cash on hand.

Real estate - Your home equity minus your total mortgage. Include 2nd homes, REIT funds, Land, or Condos.


CDs -or Certificates of deposit are issued by financial institutions such as banks and credit unions. These "Time deposits" offer a fixed interest rate if the CD is held to maturity. They come in terms as short as a month and as long as 7 years. Generally speaking the longer the term the better the interest rate but don't get trapped in a long term while rates are in an upswing. Due to higher risk the smaller the financial institution the better the rate. They are insured by the FDIC or NCUA just like most bank or Credit union accounts. There are penalties for early withdrawal. Ask about the penalties before buying as they are different for each term and each different financial institution.


Here are some examples of diversification of your "Stable" investments with an average risk tolerance.

Age 20 renter  
80% Stocks
5% US bond fund
5% TIPS bond fund
10% Cash in a Money market account


Age 30 new home owner
70% Stocks
5% US bond fund
5% TIPS bond fund
5% International bond fund
5% Corporate bond fund
5% Cash in a Money market account
5% CD's

Age 40 Mortgage 60% payed off.
60% Stocks
5% US bond fund
5% TIPS bond fund
5% International bond fund
5% Corporate bond fund
5% Cash in a Money market account
5% CD's 
10% Real estate value 


Age 50 Mortgage 90% payed off
50% Stocks

5% US bond fund
10% TIPS bond fund
7.5% International bond fund
7.5% Corporate bond fund
5% Cash in a Money market account
5% CD's 
10% Real estate value 
 
Age 60 House paid off
40% Stocks
10% US bond fund
10% TIPS bond fund
10% International bond fund
10% Corporate bond fund
5% Cash in a Money market account
5% CD's 
10% Real estate value 

You may notice that the real estate value stayed at 10% throughout my examples. This is because as home equity increases so does your other investments. If you end up heavily weighted in real estate near the end of your mortgage that's OK as long as your other investments start to eclipse that value as you progress. Some folks don't like to include the real estate value because you have to live somewhere and homes are not liquid. I personally like to run the numbers both ways.

Extension of Social Security payroll cuts

So Congress seems set to continue to provide 2% of tax relief for all of us workers. I see this as a political football that will further jeopardize the solvency of the SSA. If the government is not willing to save for my retirement I guess I will have to pick up the slack. The day we got the 2% reduction I went to my HR dept. and asked  to up my 403b contributions by 2%. I did not notice the change and I now have control of more retirement money and the government has less. This could work out in your favor if you don't spend that tax break.

I will be back on track with Anyone's financial plan in a day or two. I thought this timely topic needed addressing right away. Thanks for reading!

Brandon thefettler

A question

I got this question the other day and thought I would share.

I have a question not directly related to retirement: do you have any advice on saving a decent amount towards a future expense? i.e. preschool in a year or two for your toddler

Go to your companies payroll dept or person and ask to redo or update your direct deposit form. Have a predefined amount deposited in a "high" interest savings account biweekly.

If you have a specific amount as a goal lets say $2000 in two years. Divide 2000 by the number of pay periods between now and then, in this case it's 52. That gives you $38.46 or $39 deducted from each paycheck. You can redirect multiple amounts to multiple accounts. You won't even notice it's gone. This is how I fund my wife's Roth IRA.

If you had a five years or more before you needed the money I would recommend an online brokerage account. That way you could invest the money a little more long term.

For your current time window I would use an online savings account or start up a CD ladder (watch your time horizon on CDs). You should be able to find 2% out there. Check bankrate.com for the best interest rate.