Mutual Fund picks for Roth and Brokerage account

I recently made a Roth IRA contribution for my wife and myself. Over the past several years, all these contributions have gone to broad market mutual funds maintaining my asset allocation of 10% bonds, 90% stock (with stock being split between international, emerging market and US). However this time, I decided to get a little bit more adventurous. I purchased $4000 worth of KBE in my wife's Roth account. Banks have been hammered in the last several months and this ETF is yielding around 6% in dividends alone. Of course the situation could get worse but in the long term I think the banks are likely to rebound.
http://finance.yahoo.com/q?s=KBE.

In my Roth IRA I continued building my holding in VASGX (Vanguard Life Strategy Growth Fund) http://finance.yahoo.com/q?s=VASGX. This one is an asset allocation fund with investments in US, International, emerging stock market indices and 10% in bonds.

This time I also got a good amount of refund in taxes (need to adjust my tax withholding for 2008) and I also expect to get a check due to President Bush's stimulus package in May). A friend of mine told me about this Oakmark mutual fund that seems to have had spectacular performance since inception. OAKBX (http://finance.yahoo.com/q?s=oakbx) has around 60% in equity and has performed well. I wanted to pick this up in my Roth account, however Oakmark allows new investors to invest in them only through them directly. I did not want to open a different Roth account. So my tax refund and the economic stimulus package check are going into that fund.

I also considering bolstering up the REITs (Real Estate Investment Trust). I have VGSIX http://finance.yahoo.com/q?s=VGSIX in my portfolio that has also been hammered with the real estate prices dropping. However, I will wait a little bit before adding to REITs (I believe the real estate market might get impacted further with the financial crisis).

Tax software

You can usually get a discount on tax software such as turbo tax by going through financial institutions web sites. I know vanguard (www.vanguard.com) account holders can get a discount of 35% on the online version of Turbo Tax. Their premiere account holders can get turbo tax for free.

Bank of America used to have a similar discount last year but it looks like they have discontinued that.

Relocation and tax witholding.

A couple of years ago, I relocated from the east coast to the west coast of the US, to pursue a new opportunity. The company that I was joining paid for all the relocation costs. However a bunch of the relocation expenses are not tax deductible and show up in the W2 as taxable income. Although my company grossed up the amount (compensated me for the tax impact of these expenses), I ended up in a higher tax bracket that I had anticipated, had some deductions (like child tax credit) phased out. Overall I paid more taxes than I had anticipated.

When companies calculate the gross up amount, they look at the tax withholding rate of the employee. In hind site, when I relocated, to compensate for being pushed to a higher tax bracket and phased out deductions, I should have reduced the tax withholding on my W2 to reflect the higher tax bracket the relocation expenses paid by my company would put me into. While this would have reduced the cash that I got on hand, I would have received a more accurate (and higher) gross up on taxable relocation expenses from the employer which would have compensated somewhat for the higher tax rate that I found myself in.

If you end up with too much being withheld, you would get a refund back in the 1040 next year.

All you need to know about Certificates of Deposits.

What are CDs?
When you open a CD or a Certificate of Deposit with a bank or an institution you deposit money with them, for a fixed period of time, also known as the term of the CD. A CD also has a defined interest rate. The interest rate is usually quoted in terms of an annual interest rate – meaning a 6 month CD with a rate of 5% would earn 2.5% during its 6 month term. The term is the period in which the CD matures (i.e. you can withdraw your initial deposit without any penalties). Some CDs pay interest every month, whereas others pay interest at maturity.

CDs usually offer a higher interest rate than a savings account, since you are committing to hold money in the bank for the term. There usually are penalties if you withdraw the money before the completion of the term. The penalties differ greatly between banks.

What is the role of a CD in your portfolio?
CDs offer modest return and the interest earned is taxed as ordinary income every year. They are good instruments to earn a higher return on emergency cash and planned short term expenditures - for instance, saving for a down payment on a house that you plan to buy in two years or a car that you intend to purchase next year.

Usually CDs are FDIC insured up to the limit of $100,000 for total deposits with the institution - meaning that the government guarantees the CD if the bank goes under (check with the bank or institution before opening the CD). CDs offer a relatively low return at low risk and are usually *not* good vehicles for long term investments such as retirement savings or your child’s college savings.

What you need to know when opening a CD
A lot of banks offer CDs that have no minimums (e.g. ING direct http://www.ingdirect.com/). I am a big fan of these since they allow you to break up your principal amount across multiple CDs of smaller denominations each. Let’s say you have $10,000 to invest in a CD. In such cases, rather than opening one CD of $10,000, it is may be better to open 10 CDs of $1,000 each (you may choose even smaller amounts than that). This gives you the flexibility to withdraw money and incur penalties on smaller sums, if in the future you need to withdraw money to cover emergency expenditures before the CD matures. Let’s say you need $1800 before the CD matures. If you have multiple CDs of $1000 each, you can cash out two $1,000 CDs and incur an early withdrawal penalty on just those two. If you had one big CD of $10,000, you would have to incur penalty on the entire amount of $10,000.

Breaking up the deposit amount into multiple smaller amounts also has the benefit of allowing you to stagger the terms of the CD. Longer term CDs usually offer a higher interest rate than shorter term CDs (this is not always true). In the above example, you spread the $10,000 in 10 CDs of $1,000 each with maturities of 6, 12, 18, 24, 30, 36, 42, 48, 54, 60 months. When any of your CDs matures, you convert it to another 60 month CD. This ensures that you have a portion of your money maturing every 6 months to cover any unexpected expenses and gradually all your CDs are earning the higher interest rate of a long term 5 year CD. This is also referred to as laddering.

When are CDs not for you?
When you are saving money for goals that are longer term in nature – such as retirement or college savings, you are probably better off with investing your money in a portfolio of stocks and bonds. Also you have to weigh the tradeoff between a savings account and a CD. CD earns a slightly higher interest rate at the cost of locking your money in for the term.

Useful links:
To check the latest rates of interest on CD check out http://www.bankrate.com/.
Some banks offering good CD rates:
1. ING Direct http://www.ingdirect.com/
2. HSBC Direct http://www.hsbcdirect.com/
3. Countrywide http://www.countrywide.com/ (some mortgage companies have started offering great rates to attract cash)

Keeping the family in synch with finances

I often come across couples where one or the other manages the family financials. We fall in this category as well. I am a personal finance junkie and my wife has little interest in it - so I end up managing most of the finances for our family. To keep my wife in synch, we do the following:

• First, I try to consolidate our accounts to as few as possible. To this end we have done a few things: rolled over prior 401K accounts into a single IRA, moved all investments into 2 brokerage accounts, and closed some bank accounts that we were not using. However having a small number of accounts is not easily achieved. We still end up with a handful of accounts: I have a 401k and a stock grant account at work, a traditional IRA which has roll over from previous 401Ks, we each have a Roth IRA, one 529 account for our kids, one checking/savings account with one of the large banks, two online savings account with a high yield bank (we could go for one but I do not want to break the CDs that are in the other), one brokerage account (in which we do regular investments). We also have savings accounts for our kids in online banks and are planning to open up brokerage accounts for them. So we can reduce the number of accounts but cannot get to a few accounts.

• Next, we create a list of all our accounts every year with account information and balances. We also add to the list our life insurance information (through work and outside), active credit card accounts, mortgage account and different frequent flyer accounts. For each account we list our account number, online access ids and passwords, and balances that we have. We keep this list in a safe place that my wife knows how to access.
  

• We also have a will that defines custody for our kids and beneficiaries for our accounts.

Here is the template that we fill out every year. http://mtgoyal.googlepages.com/Accountinformationshell.xls

Please share things that you are doing to keep your family in synch on finances. Comment on this blog or write to me at tgoyal@hotmail.com.

Earn higher returns by investing regularly

If you invest a fixed amount of money in a mutual fund periodically, you can boost your returns. This method, called dollar cost averaging, is a simple way for investors to accumulate wealth and earn a good return on their investment. If you have a certain amount of money to invest, it is better to purchase equal value of the investment at periodic intervals.

There are obvious reasons for which dollar cost averaging is very beneficial. First it lets you avoid taking a big stake in a security when its value may be high. If the security loses a value initially, it can take a long time for you to recover the initial loss. Since I have never been able to time the market, I like buying periodically. Second, most of us with a paycheck get paid at periodic intervals. Setting up an automatic investment plan that invests money at these intervals also helps from a cash flow perspective. But the third reason that I like dollar cost averaging is that it can help you get a higher return on your invested capital. This is because when you purchase a fixed value of a fund periodically, you automatically buy more units when the price is lower and buy fewer units when the price is higher. This results in a higher return on your investment. Today, I am going to illustrate this with a contrived example.

Let’s take a mutual fund whose price on December 1^st and August 1^st was $100. Let us assume that we were on an automatic investment plan purchasing $200 worth of this mutual fund at the beginning of every month. Our total investment in this example for the 5 month period would be $200*5 or $1,000. The price of the mutual fund varied over the dates when we purchased the stock. On the first of Aug, Sept, Oct, Nov, and Dec, a mutual fund unit was priced at $100, $70, $100, $130, and $100. The following table illustrates the number of units that we would purchase over time.

The value of our investment at the end of 5 months is $1,040. The total money we invested was $1,000. This resulted in a return of 4% over the 5 month period. So although the mutual fund price went up by 30% and went down by 30% off the price you purchased, you still came out ahead.

We can explain this magic of dollar cost averaging as follows. In Sept, when the price of the mutual fund was lower, because we were still purchasing mutual funds worth $200, we purchased more units (2.86 units). In Nov, when the price of the mutual fund was higher, we purchased fewer units (1.54 units). Since we are investing the same amount of money every month, we automatically purchase more units when the price is lower and purchase fewer units when the price is higher, giving us higher returns. In the above illustration, if we had invested the entire capital of $1000 on August 1^st, our return would have been zero. This example is made-up and assumes a very high volatility to amplify the impact and has the same price in the first and last period to make it simple. But it is still useful to illustrate the benefit of dollar cost averaging.
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Refinanced without costs...

A couple of weeks ago, I had written about the merit of refinancing without paying costs (see: It does not make sense to pay for refinancing your mortgage…).

Following the same thought, this week, I was able to refinance my mortgage at a fixed rate of 5.875% for a 30 year term with a lender's credit of $2,800. Interestingly, I am using the same lender that issued my current 30 year fixed mortgage of 6.125% in December 2006. The closing costs this time are estimated to be $2,400, which is slightly higher than what I paid last time. Since the lender's credit of $2,800 is higher than the estimated closing costs of $2,400 I will get a one time benefit of $400 at closing. My current loan has 28.5 years left on it. Since I plan to pay off the new loan in the same term, I will see a savings of $50.70 a month, or $608.38 a year.

I also had the option to receive a slightly lower rate if I was willing to pay for the closing costs. However as last time, the math again was in the favor of a slightly higher rate with no closing costs.

Leave a comment or contact Tarun at: tgoyal@hotmail.com