13. Re-balance annually.

13. Re-balance annually. 


Every year you need to re-balance your investments. Don't forget to adjust your asset allocation as you age (See steps 12a-12c). Use this adjusted allocation as your goal. Your Birthday or the New year are great cues to remind you to re-balance. 

Re-balancing means selling issues that you are overweighted in. You then buy into investment classes that you are underweighted in. For a simple example let's say I set my Small Cap allocation to 5% of my portfolio. Last year that grew to 7%. I also set my international stock fund to 5%. Last year it fell to 3%. To keep my investments in line with my asset allocation I should sell 2% of the Small Cap fund and buy 2% of the international fund. This forces you to sell high and buy low.


Keep in mind the 1% rule of expenses. If it would cost more than 1% to re-balance don't bother. This happens in the beginning of your investment life. Values are so small it doesn't make sense to sell. In this case you want to buy into balance. This is done by monthly buying into the class you are lowest in until you hit your allocation in that class. Then move on to the next lowest class. 

Here is an example of a 50 year old with a little over 100k invested. With a $4.00 transaction fee you can move up to $400.00 at a time. If you are out of balance by less than that, It is not worth the fee to re-balance that class.

Age 50 Mortgage 90% payed off	Old total	Sell	Buy	Fee	New total	Goal
7% Large Cap stock fund	6,500.00		500.00	4.00	7,000.00	7,000.00
6% Mid Cap stock fund	7,256.00	1,256.00		4.00	6,000.00	6,000.00
6% Small Cap stock fund	8,400.00	2,400.00		4.00	6,000.00	6,000.00
10% International stock fund	7,400.00		2,600.00	4.00	10,000.00	10,000.00
6% Growth stock fund	6,050.00				6,050.00	6,000.00
7% Value stock fund	6,223.00		756.00	4.00	6,979.00	7,000.00
8% Emerging market stock fund	8,500.00	500.00		4.00	8,000.00	8,000.00
5% US bond fund	4,100.00		900.00	4.00	5,000.00	5,000.00
10% TIPS bond fund	11,700.00	1,700.00		4.00	10,000.00	10,000.00
7.5% International bond fund	6,400.00		1,100.00	4.00	7,500.00	7,500.00
7.5% Corporate bond fund	7,300.00				7,300.00	7,500.00
5% Cash in a Money market	5,025.00				5,025.00	5,000.00
5% CD's	4,000.00				5,000.00	5,000.00
10% Real estate value	10,000.00				10,000.00	10,000.00

I have an asset allocation excel spread sheet starter I can email you if you like. You plug in your numbers and it will do the math for you. Just drop me a line at thefettler@yahoo.com

HSA Health Savings Account question

 A reader asked me this question. "I am considering a high deductible health plan that qualifies me to fund an HSA. What happens to my HSA if I get employer based coverage and am no longer HSA eligible?"

Money in your HSA is your property the moment it is deposited. If you no longer have an HSA eligible policy you can no longer make deposits to your HSA account,  The funds remaining in your HSA are still available for qualified medical expenses regardless of your coverage type.  


An interesting HSA fact. You can roll over one years worth of HSA deposits from an IRA ($3100.00 for 2012). I would not recommend doing this unless you are in a medical/financial bind. You can only rollover funds once in your life and you can't roll funds back to the IRA. 


When comparison shopping for HSA providers try to compare expense ratios. Lower fees will help you get a better return on the investments in your HSA. This may be harder than checking stock or bond expense ratios. Insurance companies are not legally required to be forthcoming with their fee schedule (yet!). But ask the rep. when you call anyway. 


Make sure to keep detailed records of your medical expenses. That will save you a bunch of time and heartache at tax time.

12c. Create an asset allocation. Part C - Equities

In Part C we will discuss different types of Stocks or "Equities".


There are two types of stocks Common and Preferred. With both types, face value is market determined. Common stocks are the most popular. They come with voting rights and the dividend can be adjusted or eliminated at will. Preferred stocks offer a permanent dividend level set at purchase and can be "Called" or bought back by the company (at a premium). In bankruptcy they are payed back before the common stock is. But the downside to Preferred stocks is no voting rights. We will be dealing with common stock in this blog.


As we discussed in part B there is a huge difference in homework between buying individual issues and funds. I do not, nor do I recommend buying individual stocks. Even professional fund managers have a hard time beating the market. From here on out we will be discussing the different types of stock (equity) funds.


Large Cap funds
Or large market capitalization are funds holding stocks of US companies that have 10 billion or more dollars of market capital. You get this number by multiplying the number of outstanding shares by the price per share. GE, Google, and Apple are examples of large cap companies.


Mid Cap funds
Or middle market capitalization are funds holding stocks of US companies that have 2-10 billion dollars of market capital. They tend to be a little more volatile than the large cap companies. Monster Beverage corp, Del monte, and American building maintenance, are examples of  Mid cap companies.


Small Cap funds
Or small market capitalization are funds holding stocks of US companies that have 300 million - 2 billion dollars of market capital. They tend to be more volatile than the large or mid cap companies. The reason there can be such an upside to small cap funds is that you beat out institutional investors that have market cap minimums. Buffalo wild wings, Playboy, and Spherion, are examples of Small cap companies.
 
International stock funds
Funds that invest in companies outside the USA. They can invest by country, region, continent, or everything but the US.


Growth stock funds
Funds that invest in companies that are considered to have above average earning potential. Most technology companies are growth companies. You make your money when the company grows and the stock value increases. Growth stocks rarely pay out dividends due to reinvestment of the profits into the company.


Value stock funds
Funds that invest in stocks that are undervalued compared to their peers. They usually have a high dividend to attract investors.


Emerging markets stock funds
Funds that invest in companies that reside in countries that are financially progressing. The country must have a unified currency, stock exchange, and some sort of regulatory agency. The potential for for large growth is tempered by high risk.


Dividend stock funds
Funds that invest in companies that pay out high dividends. You make your money from the dividend stream not as much from growth.


There are plenty of other types of funds out there. I feel that most of them tend to be niche funds. This works against diversification. It is a lot like buying individual stocks which is a fools errand.


The biggest thing to consider when choosing funds is expenses. Low fees are a great indicator of a well run financial institution. You should never pay more than 1% per year in annual expenses (preferably under 0.6%!). If the fund is part of a 401k/403b you can accept up to 1.5%. To find a funds total annual expenses find the expense ratio in the funds prospectus. You may have to add all of the various fees listed. I have a short list of 5 companies that I buy funds from for my Roth IRA. They are Vangaurd, Ishares, Global X, Fidelity, and Morgan Stanley. You will have less choices in your 401k/403b.


Here are a few ways to buy into these types of funds.


Mutual funds
A mutual fund is a basket of funds that are actively managed by a fund manager. There is usually a minimum amount that must be invested at a time (5k is common). They have a higher expense ratio due to management costs. Mutual funds tends to cost more in capital gains and taxes. This is due to the amount of trading the fund undergoes.


Index funds

An index fund is a basket of funds that "index", follow or mimic a certain market. Index funds are cheaper because they do not require active managing. Software re-balances the fund to keep it in line with what it's indexing. Since there is much less trading in an index fund the capital gains costs are very low. 

ETFs
Or exchange traded funds are index funds that are traded like stocks. There are no minimums and the low cost and tax efficiency makes them my personal favorite flavor of fund. Their only drawback (or benefit if you invest a larger sum) is that you pay the same brokerage fee if you buy 1 share or 1000. Just make sure your purchasing fees do not exceed 1%.


Here are some examples of diversification of all of your investments with an average risk tolerance. 
Age 20 renter    
10% Large Cap stock fund  
10% Mid Cap stock fund  
10% Small Cap stock fund  
10% International stock fund  
10% Growth stock fund  
10% Value stock fund  
10% Emerging market stock fund  
10% REIT fund*

5% US bond fund

5% TIPS bond fund

10% Cash in a Money market account

Age 30 new home owner

8% Large Cap stock fund

8% Mid Cap stock fund

8% Small Cap stock fund

10% International stock fund

8% Growth stock fund

8% Value stock fund

10% Emerging market stock fund

10% REIT fund*

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

I left the International and Emerging funds alone. This helps keep your foreign exposure balanced.

Age 40 Mortgage 60% payed off.

8% Large Cap stock fund

8% Mid Cap stock fund

8% Small Cap stock fund

10% International stock fund

8% Growth stock fund

8% Value stock fund

10% Emerging market stock fund

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 

As your home equity is established you can pull back on your REIT fund holdings. If you do not own real estate you can keep 10% in a REIT fund perpetuity.

Age 50 Mortgage 90% payed off

7% Large Cap stock fund

6% Mid Cap stock fund

6% Small Cap stock fund

10% International stock fund

6% Growth stock fund

7% Value stock fund

8% Emerging market stock fund

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

5% Large Cap stock fund

5% Mid Cap stock fund

4% Small Cap stock fund

10% International stock fund

5% Growth stock fund

5% Value stock fund

6% Emerging market stock fund

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 

Remember to factor in all of your investment vehicles in your asset allocation. 401k/403b, Roth/IRA, Brokerage account, and Bank holdings (CD's Savings etc...) Your 401k/403b may have less choices. This may cause you to pick up the slack with your Roth/IRA. Remember, This is not an exact science. The goal is to not let any one investment class get too big.


*REIT or Real Estate Investment Trust are funds that hold investment grade mortgage backed securities (Commercial and or Residential). Don't be scared of these funds. If you buy from a quality issuer they are safe enough and a good stand in for home equity.

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.

12. Create an asset allocation. Part A

12. Create an asset allocation based on you risk tolerance. This is easier than you think.

Simply put, an asset allocation is just how you divide up your savings and investments. Matching your more stable assets (Bonds/Cash/Real estate) to your age is the basic rule of thumb. i.e. if you are 40 you should hold 40% in stable assets and 60% in stocks. If you feel that you would need or like a more aggressive portfolio you could subtract 10% from your age. Or if you think the stock market is too unstable you can add 10% to your age. Make this as simple or as complex as you like. Here are some examples of basic asset allocations. In part B and C I will break down different types funds so you can see more detailed portfolio examples.


Age 20, single, renter
90% Stocks
10% Cash


Your young and can easily recover from set backs. Go with a broad based stock market index fund and just use cash for the safe 10%. A simple and aggressive portfolio is very appropriate.


Age 30, Just married, no children, new home owner
70% Stocks
30% Bonds/Cash


Just starting out in life land maybe a family. An average portfolio is probably the ticket.


Age 40, Married, two children, renter
60% Stocks
40% Bonds/Cash


Average


Age 50, Married, 2 kids in college, 10 years left on mortgage, Health issues
40% Stocks
60% Bonds/Cash/Home equity


With all of your obligations (Tuition, Mortgage, Health care) you should be more conservative with your portfolio.


Age 60, Single, No children, House paid off, Healthy, Not much saved
50% Stocks
50% Bonds/Cash


You don't have a lot of obligations but you don't have a lot saved. An aggressive portfolio may be quite helpful in this situation just remember to always reference your age.




This is completely a judgment call on your part. A financial pros and cons list. Account for all the variables that only you can know and get feel for your risk tolerance. If you just don't know what to do then go with your age.