No Debt Plan

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Last week I told you how to make sure your money was safe from a bank failure. As I did my research on the topic, I discovered that IRA accounts are also covered at those banks. The FDIC insures your individual retirement accounts up to $250,000.

One of the questions I have received via e-mail in the past revolves around IRA accounts. Namely, if I have a Roth IRA with Bank A, can I open a new one with Bank B? Or are my options unlimited in regards to the number of different individual retirement accounts I can have?

The short answer is yes, you can have as many IRA accounts as you wish. You could open an IRA account up with 100 different banks if you felt the need. Of course you don’t really want to do that. Consolidating into one IRA account with the highest number of quality, low cost investment options would make your life a lot more simple. (Unless the institution it is held at fails.)

You can also have both a Roth IRA and a Traditional IRA. No matter how many IRAs you have you must remember you can only invest the maximum amount across all accounts. Currently that maximum is $5,000 for most people. If you have a Roth IRA and a Traditional IRA you could put $2,500 into each account for a total of $5,000 (rather than $5,000 into each and a $10,000 total).

As I was planning to write this article, Patrick at Cash Money Life put up a great article about the number of different retirement accounts you can have (401k, IRAs, all of them).

What if I have more than $250,000 in my IRA?

As I mentioned at the beginning if you have a Roth IRA with IndyMac Bank and it has $600,000 in it… the FDIC will guarantee the first $250,000. You may be able to get the remaining $350,000 from the bank eventually, but it would be quite disheartening to see more than half of your investment move out of your hands for a while. Disheartening is an understatement. If $350,000 of my money suddenly was inaccessible I would be freaking out.

I can understand in this situation some might consider opening up a second IRA with another institution to hedge your bets against failure.

But remember, bank failures don’t happen every day. And opening up a second IRA with a different institution does not ensure you will enjoy the same low cost investments as with your first IRA. I would recommend finding a quality institution (we use Vanguard) to keep your IRA safe. Plus, I wouldn’t recommend using a bank in the first place as they usually don’t offer the cheapest investments.

I have a guest post that will go live at Consumerism Commentary at 10AM Central that talks about what I see as the benefits of target retirement funds. If you’re visiting from Consumerism Commentary, thanks for stopping by! Please consider subscribing to my RSS  feed and commenting. Your comments are more than welcome.

I thought I’d pair it up with further thoughts this morning about the beauty of automatic rebalancing with a target retirement fund.

We need a foundation of understanding first.

What is rebalancing your portfolio?

Essentially, rebalancing your portfolio is buying/selling certain portions of the portfolio so that the items you are invested in match your investment plan. That doesn’t sound simple, but it is. Let’s say you want to be invested in 90% stocks and 10% bonds. During the year each is going to go up and down, and you might end up one year later with 95% stocks, 5% bonds. Your asset balance is out of whack.

So you sell some of your stock holdings or add more to your bond holdings to get back to your 90% / 10% balance. Every time you do this you are rebalancing your portfolio.

Rebalancing is easy and you probably won’t do it

Many people get busy and forget to even look at their 401k statements or where there investments stand on a year to year basis. Adding in yet another thing you have to do, especially if it involves a little math, makes it more unlikely you will rebalance.

I’ve read elsewhere that many people are invested in ultra-conservative investments in their 401k. Why? Because they don’t know what they’re doing and the “guaranteed return” on a money market fund paying 2% sounds great. If you don’t understand the investments, you probably don’t have an investment plan (which I will talk on in the future). If you don’t have an investment plan, how are you supposed to know what to buy/sell more of to get your portfolio back in balance? It’s a simple concept, but requires a few steps. Result? Most people don’t do it every year.

The Beauty of Target Retirement Funds

One of the most amazing things about Target Retirement funds is they rebalance for you. Automatically. You don’t have to even think “man, what should I buy more of? What should I sell?” The funds automatically adjust for you.

Over time the funds get more conservative. That makes sense. If you are 42 years from retirement (Vanguard Target Retirement 2050) you need more stock holdings in your portfolio. Stocks provide more growth over time than bonds even though there is risk involved. But if you are retiring in two years (Vanguard Target Retirement 2010), you can’t afford an enormous loss in 2009 right before you start drawing income from your retirement account. So as time marches on the funds boost up the bond holding percentage to provide more stable income.

Let’s compare the 2050 fund and the 2010 fund over the last year to prove the point. Remember, the 2010 fund is invested more conservatively with a higher percentage of bonds. The 2050 fund has more exposure to stocks. The blue line is the 2010 fund, the red is 2050. You can click the image for full size.

What do we see? The last year has been a wild ride on the stock market. The fund with the higher allocation of bonds — 2010 — has not experienced as big of a gain or loss over the past year. It comes out to be about 1/2 of what the heavy-stock allocated fund experienced.

That’s to be expected. But just think if you are about to retire, and you are invested in the 2050 fund. You have lost 7-8% over the last year! That can really put a dent into a retirement portfolio. But thanks to the target retirement fund if you have the right date picked out (2010 versus 2050), the funds will automatically get more conservative for you. End result? Hopefully less retirement headache.

I highly recommend starting your Roth or Traditional IRA with a Target Retirement Fund. It is definitely a set it and forget it type investment, which makes things easier for you. I do recommend Vanguard, but I will put up a disclaimer: I am invested in the 2050 fund. That’s it. Vanguard doesn’t pay me to toot their horn. The low fees and exalted status in the investment world is all I need to talk about them.

Some exciting news on the personal front for me. A few weeks ago I was asked if I would be interested in being an MBA member of a team that manages an investment fund at the school where I’m getting my MBA. The fund is $500,000 that was given to the school to be used to help teach investing to students. I’ll be working with undergraduate and MBA students to help guide where the fund invests.

I join this fall, so it should be interesting. Can we pick index funds? I’m guessing not, but…

CNN Money thinks you only need 7 investments. I think that is four to six too many for the average investor.

Here is the list of investments Money Magazine thinks you need:

A blue chip US-stock fund (track the S&P 500 index) (Fidelity Spartan 500 Index, FSMKX)

A blue chip foreign-stock fund (track the international stock index) (Vanguard Total International Stock Index, VGTSX)

A small company fund (T. Rowe Price New Horizons, PRNHX)

A value fund (Vanguard Value Index, VIVAX)

A high-quality bond fund (Vanguard Total Bond Market, VBMFX)

An inflation-protected bond fund (Vanguard Inflation Protected Securities, VIPSX)

A money-market fund (Fidelity Cash Reserves, FDRXX)

If you made it to the end of that long list, congratulations. For the 50% of you asleep at the computer, I apologize.

Seriously, 7 funds is “all” you need? The above is just fine. It covers every single aspect that you might ever want to possibly cover.That’s great and all, but…

7 Funds is Complicated

We live in a society with a negative savings rate. You’re telling me that I am somehow going to convince Mr. Average American to invest not in one fund. Not in two. Yes, seven sounds is just right.

7 funds is very complicated. Here’s a few reasons why (I’ll show you the alternatives in a moment):

• Each fund has a minimum required investment. The more funds involved, the more minimum required investments required. The combined minimum required investment for the above seven funds is $24,500! The Vanguard funds are all $3,000 (four funds), the T.Rowe Price Fund is $2,500, and the Fidelity S&P 500 fund is $10,000. The money-market fund isn’t publicly traded from what I can tell; I’m not sure if it has a minimum or not. Even if you dropped the Fidelity S&P index in favor of its Vanguard brother (VFINX) your minimum required investment is still $17,500. If you gave each fund equal weighting, or $3,000 for each of the seven, you would need $21,000. That’s a ton of money if you are just getting started.
• There are three fund companies on the list. “What’s wrong with three companies? Shouldn’t you pick the best funds?” I’m pro-Vanguard and not afraid to admit it. However, You should not stick with a fund company if there are better options out there. In this case, suppose you’re investing in a Roth IRA. To get all of the above mentioned funds, you first have to find a brokerage that gives you access to all of the funds. After that, you’ll be paying fees to trade your mutual funds. Fees = less money for retirement. If you stuck with one company such as Vanguard and swapped out the funds for comparable ones, you would avoid a lot of those fees.
• If you’re investing in an IRA (traditional or Roth), you are limited on the amount of money you can invest each year. This goes with my first point — you would need $17,500 to $21,000 to get started with this plan. An IRA limits you to $5,000 worth of contributions per year right now. You now have to enact this plan over a four year period, making it all the more likely you will never complete it.
• ETFs might serve you better. If you are investing a lump sum — that is, if you had $21,000 to invest right now — ETFs might serve you better. You would pay a brokerage fee ($6.95 at Firstrade) and then a much lower annual expense fee versus the mutual fund. If you’re invested over time (e.g. $3,000 at a time) then a mutual fund would be the better option for you.

Two Alternatives

Investing and retirement do not have to be that complicated. Honest. Remove the glitz, the glam, and the extras. In my eyes, you have two easier options.

Here’s what I recommend:

• One fund. A Target Retirement Fund will take care of everything for you. These funds are a “fund of funds”… so they buy other funds to hold in the fund’s portfolio. For example, many of Vanguard’s funds invest in the Total Stock Market, Total Int’l Stock Market, Total Bond Market, Euro/Pacific funds, and allocate them base on what fund you buy (the later the year on the fund, the more stock-heavy it will be). A target retirement fund is a “set it and forget it” option if you don’t want to think about which funds to invest in.
  • Example Portfolio:
    • Vanguard Target Retirement 2050 (VFIFX)
• Three funds. If that is just too simple for you, invest in an all encompassing US-stock fund, an all encompassing Foreign-stock fund, and a bond fund.
  • Example Portfolio:
    • Vanguard Total Stock Market (VTSMX)
    • Vanguard Total International Stock Market (VGTSX)
    • Vanguard Total Bond Market (VBMFX)

The best thing about a Target Retirement Fund is it is easy to get started. With the Vanguard fund mentioned above, you need $3,000 to invest. Once you’re invested, you not only have instant diversification, but you can then contribute as little as $100 at a time. With each additional fund you want to participate in, you need another $3,000.

I think Money’s intentions were good here and I don’t have anything personal against the funds they mentioned. (Well, except the Fidelity S&P 500 fund. $10,000 minimum investment? Are you kidding?) I sincerely think seven funds is too much. You end up sharing a lot of the same stocks in many instances.

Chris commented on my post, One Simple Step to Retiring with $1,000,000, with a question about Roth IRA minimums.

You say the max is $5,000 is there a minimum? If I can’t afford to do the $416.67 per month, what is the lowest that I can go without any kind of penalty. Or can you go without putting anything in for a year or two, not that you would want to do that. Just curious, I’m not completely familiar with the way the Roth works. Thanks Kevin!

The best answer? It depends.

There could be a few different minimums: minimum to invest in a mutual fund, minimum amount required to open the account with the firm, or minimum amount you can add additional funds to your account with.

There are a multitude of places you can setup your IRA/Roth IRA. A bank, brokerage firm, or directly investing with a mutual fund/investment firm are a few options that come to mind. Each is going to have different requirements of you to open up an account.

For example, we use Vanguard for our Roth IRAs. To invest in Vanguard’s mutual funds — through Vanguard or a brokerage firm — you need $3,000 as a minimum to invest in that mutual fund. The only exception is the Vanguard STAR fund with a minimum of $1,000. Everything else you need $3,000 to get started. However, after that the smallest amount of money you can then add to that fund is $100 if I remember correctly. You don’t have to save up $3,000 at a time unless you want to use multiple funds. We are currently invested in a Target Retirement Fund to get started, so we have no need for another fund right now.

If you setup an account with a bank or brokerage firm you would have an array of options to invest in. Some would have higher minimums than others. Some of the firms may even require you to have a certain amount just to open the account regardless of how much you invest in each mutual fund or stock.

It really does all depend. We have been completely satisfied with Vanguard in the short time we’ve been with them. We didn’t have $3,000 saved up initially, but just set aside money each month until we reached the minimum.

My advice? Just get started today. Do whatever it takes. Set the money aside in an online saving account like ING until you have enough to start investing. Step by step you will get there. Just remember the first step is always the hardest.

Update #2: I also answered a question from the comments below in a different post. It addresses Roth IRA minimums.

Update: Hello StumbleUpon users! Learn more about me or read some more articles. Thanks for all of the up votes! Please leave comments on your thoughts. We had a bit of discussion over at Stumble Upon with some of the reviews, so check those out, too.

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I’ve got a keen interest in learning more about how changing one thing in your life can have a huge impact further down the line. More on that in the future.

The Roth IRA is one of those changes. One simple decision that can truly change your life.

The government allows you as an individual to set aside $5,000 (as of 2008) per year of after-tax money for your retirement. I decided to use the Roth for this example because it eliminates taxing gains on your investment, which makes the example a lot more simple.

So what happens if you start early and set aside just $5,000 per year?

Let’s run the numbers.

Using Excel, you can calculate what amount of money you would end up with based on the following criteria. I’m using myself as an example because, well, I know everything about me.

• Age: 24
• Retirement: 66 (I would rather retire earlier than this, but am willing to work this long)
• Annual Contribution: $5,000 after-tax dollars
• Annual rate of return: This can vary greatly. We’ll stick with a very conservative 7% per year.

You can make changes and run your own calculations with my Roth IRA calculator (in Excel).

Long story short? If you start early, you can retire as a millionaire by just using one investment vehicle. No need for five different accounts with three different brokers. A simple Roth that through whatever investments you chose earns 7% per year, nets you $1.2 million (give or take some due to rounding error). You can see a chart of your cumulative contributions compared to the balance in the account. See how much you are earning at the end without having to put more money in — the beauty of compound interest. (You can click on the chart to see the full size.)

For those who like easy steps:

• Pay off debt, live a debt free life.
• Commit to putting away $5,000 after-tax money into a Roth IRA. That’s $416.67 per month.
• Invest in index funds like Vanguard’s Total Stock Market, Total International Stock Market, and Total Bond Market. Lower fees = higher returns.
• Earn a ‘measly’ 7% return on your investments each year until retirement.
• Retire with $1.2 million.

Want to run your own numbers? I’ve uploaded the handy Excel workbook for you.

Nothing like some pure speculation to get the Monday morning going. What does Ben Bernanke’s portfolio look like? What is he currently invested in?

I wonder if this sort of information is available publicly. A very powerful person in the finance world. What does his portfolio look like?

I did a Google search and the only thing I can find is a CNN Money article from a few years back. Nothing more recent. The Money article did seem to mention that he had a very plain, basic portfolio with nothing really extravagant in it. He also earns a “modest” salary in comparison to what he could earn on Wall Street.

The Federal Reserve is an interesting beast of an organization. They have government-like powers, but they aren’t a government institution. Despite not being a government institution, they carry a government domain name (federalreserve.gov).

Are there rules or laws in place to limit what the leaders of the board can invest in?

What if…

• Ben bought Bear Sterns’ stock at $2 then allowed/encouraged the price to go to $10 per share?
• Every time a significant change was going to happen in the interest rates that Ben bought securities that would benefit from the lower/higher rates?

There are a bunch of scenarios you could come up with that would seem quite sketchy. Anyone out there know about the “rules” for people like Ben when it comes to investing?

I noticed that Visa (V) IPO came out earlier this month. I had been meaning to track this more closely, but let it slip by. When I heard that it was already trading around $60/share, I could feel my emotions change a bit. Anxiety kicked in — had I missed a great deal? Was it too late? What could I do to get ‘in’ on this deal?

We have a stock and mutual fund sitting in a taxable account with Firstrade. This was leftover money from our house down payments. I am waiting for the stock to recover some of its value, and for the mutual fund to go back up due to the market fluctuations recently. As I sat here at my computer pulling up information about Visa, I began pondering the use of this money. I could sell both, take the proceeds, and buy some Visa stock. It’s bound to go up, right? I mean, look at Mastercard!

Woah, tiger. Let’s slow down for just a second. That’s the thing about investing… your emotions get involved. Let’s take a look at Mastercard (MA).

It’s kind of hard to see on the above chart, but since Mastercard went public in 2006 the share price has gone through the roof. It looks like Mastercard came out at around $45 per share. The current price? $216.50 as of yesterday’s close. Wow. That’s $171.50 per share in growth, or 381% in about two years. Not half bad, even by Warren Buffett standards.

So Visa is going to do the same thing, right? Not necessarily. This is what your brain is telling you. It sees the positives of Mastercard as well as the similarities in the businesses. Skipping all other logical thinking, it encourages you to go ahead and invest… and soon! However, these are two completely separate firms. There is no guarantee Visa is going to earn you 381% returns within the next two years.

Don’t get me wrong, I think Visa is a great business. I wish I owned it. But trading in a broad mutual fund plus one stock to get only one stock is foolish. This isn’t play money we’re dealing with here. So for now, I sit on the sidelines. Sticking to our plan. Sticking to our 2008 goals. There will be other stocks in the future that I will invest in. That is a few years down the road, maybe even decades. The bottom line is to keep your emotions in check when investing.

That being said, if I had the abilities to invest in individual securities, I would invest in Visa. Have any of you out there bought some Visa stock?

There has been a discussion out in the personal finance blogging world about P2P lending. P2P means peer to peer (just like when you used Napster back in college). Except this time, you are offering to loan a stranger some of your money in return for a higher interest rate than an online savings account.

There are two primary sites that have grown into this industry: Prosper.com and LendingClub.com. I joined Prosper a while back, but never lent out any money.

Gather Little by Little thinks P2P lending is a bad idea. There were several other blog responses arguing against GLBL’s point. I sit somewhere in the middle.

It seems like a great deal for the borrower. If you can’t get a loan from a bank, or if your credit card company has jacked up your interest rate (Bank of America has done this recently) then it is a less expensive source of funds. Plus, if you are unable to get a loan anywhere else, there is still the possibility of getting the loan through P2P lending. For those borrowers, any way to get the loan is a good thing for the borrower.

For the lender, I am not convinced it is a good idea. Sure there are some checks and balances like collection agencies and credit ratings, but you are still lending money to someone that you have never seen before. You don’t know if any of the details are true on the listing. In other words, I think this is an extremely high risk venture. In today’s market you would have to be a real thrill-seeker to go after additional volatility. I wouldn’t put my retirement savings into it even if I could get higher returns.

Contest

However, if I had some ‘play’ money sitting around, I might lend it out to get a higher return on one of the sites. To that end, I am going to start a little contest. I have seen several blogs with Lending Club ads up on site. I’m guessing the person who refers you into the system will earn some sort of referral bonus. (If I’m wrong and there is no bonus then this is going to fall on it’s face!)

I will join Lending Club to earn the $25 free sign-up bonus through your referral. I’ll try to keep this as simple as possible:

• Each point you earn will put another entry for you into the contest. If you earned three points and there were only 10 total points entered, you’ve got a 30% chance of winning. I’ll take the entires and put them into a random number generator. Your number pops out, I’ll sign up through your referral.
• How to earn points:
  • 1 point - leave a comment with your referral link
  • 2 points - write a post on your blog linking back here (of course with your referral link within that post so I can sign up if you win)

Thus, you can earn up to 3 points or entries by doing both things. That’s it! The contest will end on Wednesday, March 19th at 7:00PM Central Time.

I’ve put up a question at the Get Rich Slowly forums. I’m asking for help in working through some investment questions with my parents. If you can help, I would greatly appreciate it.