Thursday, March 29, 2007

How to Invest Your 401k: A Generic Guide.

So you finally got a job with a 401k. The only problem is: what on earth are all these choices and what am are you supposed to do with them? The Armchair Fiduciary will try to answer that question for you in this brief guide to investing your 401k.

There are some ground rules. First, this guide assumes you are 40 or younger (i.e. you have a long time horizon before you need the money). Second, as is mentioned in my profile, I am not a professional financial planner. What is offered here is merely advice on how I personally would invest my 401k. You should follow this advice at your own risk. So without further adieu let's get on to the guide.

1) How Much Should One Contribute?

This is probably the first decision you will make. The simple answer is you should contribute as much as you can afford up to the maximum allowable contribution ($15,500 in 2007, $16,000 in 2008). I would put 401k investment when you are young only behind food and shelter for your family in terms of priorities.

Why? First, Social Security should be in dire straights by the time people who are young today retire. If it still exists as it does today the taxes will have to go way up (which won't be popular). If the benefits are changed it will be hard to predict what those changes might be and how they will affect your payout. The bottom-line is that the conservative approach is to assume Social Security will not be there (even though it probably will be in some shape or form). Second, savings in a 401k are tax deferred meaning that you pay income tax on the money as you withdraw it instead of when it goes in. You get to capture compound interest tax free until you withdraw money at the end. The time value of money makes this a valuable feature. There has been some debate in the popular press about whether 401ks are a good deal because current tax rates on capital gains in normal taxable accounts are 15% for long-term gains while income taxes run in the 20%+ range for most of us. I simply don't believe that long-term capital gains can stay as low as they are forever so I think over time these thing should roughly equal out (i.e. capital gains should return to the 20%+ zone by the time we retire). Even excluding that, if you ever sell any assets in your taxable account to switch into a different investment Uncle Sam takes 15% of whatever gains you have. In a 401k you can change your mind on investments without tax penalties because you only pay out taxes when you withdraw from the account. Third, many employers match a percentage of your 401k contribution. Passing on this is a little akin to volunteering to take a pay cut. Finally, I like 401ks because there are tax penalties for early withdrawals (before age 59.5). This may seem counter intuitive, but with a taxable account the money is too easy for most of us to get at. The 401k plan, because it comes with strings attached, enforces discipline and generally makes us think twice about stealing from our retirement cookie jar.

2) How Should I Split My Money Between Stocks (a.k.a. equities) and Bonds?

Generally while you are young I would encourage investing most of your 401k in equities. In fact, I personally would put the whole thing in equities. The reason is simple. Over the long-term because equities are riskier they produce higher returns. The whole point of the retirement account is to fend off inflation and then some and equities have a strong history of doing that. While US Treasury bonds are widely viewed as a "risk-free" bet, you "pay" for taking less risk by getting lower returns. Because you aren't going to touch your 401k for 20+ years you can afford to weather a few down years in the stock market. Plus, if the market tanks you are going to continue contributing to your 401k so you will buy stocks while they are "cheap". Now portfolio theorists will say I am guiding you off the capital markets line which maximizes risk adjusted return (i.e. get the maximum return for a given level of volatility). My answer to them is that on average you will want a higher level of equities if you have a long time horizon and that an average investor is unlikely to successfully calculate the optimal mix of asset allocation.

3) So How Should I Invest my Equity Portfolio?

a) To Index or Not to Index?

While I am a firm believer that there are some money managers out there that can beat the market with stock selection, I am not a firm believer that the average 401k will offer you access to many (if any) of those managers. If the plan offers index funds you should most likely go with those. If not, then you should try to find funds with low expense ratios, good long term returns, and total assets of less than $5 billion. This information can usually be found easily on Yahoo Finance. Just go to "symbol lookup," punch in the name of your fund, and then look at the "profile" and "performance" pages. You want a fund that on the profile page has net assets less than $5 billion (fund managers have a hard time outperforming if they manage too many assets in my opinion) and an expense ratio at or below the category average. On the "performance" page you want a fund that has a longer term history of beating their benchmark and peer group. If the "diff" category is a positive number that means the fund beat its peers in the category or benchmark.

b) International vs. Domestic Equities?

I think the most important decision you are going to make is the mix between US and foreign equities. I personally would divide my account into about 50% US equities and 30% developed foreign equities and 20% emerging market equities. Developed nations include most of the EU and Japan a complete list can be found here. The other 20% should go into emerging markets like China, India, Latin America, Eastern Europe, etc. A list can be found here. The reason I think you want a lot of foreign assets is simple. I am pretty confident that the balance of economic power in the world is shifting. 20-30 years from now I think China, India, Russia and others will likely have a bigger role in the global financial system than they do today. That's why I want to encourage people to invest abroad as well as in the US. I think some of the best investment opportunities in the next few decades will be abroad. Furthermore, US equities only account for about 1/2 of the world market capitalization. Owning more than 50% US equities is a bet that US equities will outperform the rest of the world and that is a bet that I don't want to actively make. Why not underweight the US? First, I think the US will hold its own during this time of economic change. Second, if you are US citizen you are going to consume your retirement in US dollars. It makes sense to have a large portion of dollar denominated assets since those are what you will need when you retire. If you had all international securities you would also be making a bet that other countries currencies appreciate against the dollar. I'm no currency expert so a 50/50 mix of dollars and foreign denominated assets makes some sense to me so you have some protection no matter what currencies do.

c) Small, Mid, or Large Cap Stocks?

I would try to get a roughly equal mix of all three of these. That means if you are looking at indexes you want something that is either a total market index (e.g. Russell 3000) or you want to own 1/3 in indexes that mimic the Russell 2000 (small cap), 1/3 in the Russell midcap (mid cap), and 1/3 in the S&P 500 (large cap). When you are making international investments you are unlikely to be able to choose an index based on market cap size. I put the mix of domestic versus international above the market cap mix in this guide because I think it is more important. If you don't have cap choices internationally in your plan I wouldn't be surprised. If this is the case don't worry about it. Just invest internationally anyway.

d) Growth vs. Value?

Growth investors try to find stocks that have great growth prospects, but tend to be a little more expensive on various financial metrics. Value investors try to find stocks that are undervalued even if the company doesn't have great growth prospects. Both strategies can work well at different times. Some academic studies have shown that value strategies tend to work better over long periods of time than growth strategies. I'd generally do a mix of about 33% growth and 66% value. I think this is one of the least important decisions you will make when allocating your 401k. You should only care about value versus growth if you don't have an index fund option to invest in.

4) Should I ever borrow from my 401k?
No! That's not what it is there for. There are exceptions- if you have a medical emergency or something and the choice is borrow from your 401k or use credit cards then you should tap into the 401k, but for the most part your 401k is OFF LIMITS!

5) I left my job, what should I do with my 401k?
In most cases you should roll it over into a traditional IRA because they offer you a lot more choices than 401k plans and are still tax deferred. Be sure to do a trustee to trustee transfer to avoid tax problems when you do the roll over.

6) Help, I am still confused!
If you are still confused or find that this information is too generic for your needs or you are over 40, don't hesitate to email me and ask more specific questions. I'm happy to look at your specific plan options and tell you what I would do. If you email a really good question be forewarned that I might turn it into a post though I will keep you 100% anonymous. Note: if this post hits the front page Digg or something it might take me a long time to respond. I do promise to try to respond to each email even if it takes a while.

Tuesday, March 27, 2007

When it comes to money, be skeptical. Always be skeptical! And watch out for Ponzi schemes in Yahoo ads.

I am always amazed when I read stories about people who got scammed on the Internet. It usually starts with an email like this one I received today:

From: Mr. Alvin Garry.Ernest OppenheimerRoad Lake,5743.JohannesburgSouth Africa. (CONFIDENTCIAL)I know that This letter might surprise you because, we have not met neitherin person nor bycorrespondence. But I believe it is one day that you get know somebodyeither in physical orthrough correspondence.How ever My name is Mr. Alvin Garry, I want to transfer ($125,000.000.00USD) One Hundred &Twenty five million United States Dollars from a Prime Bank here in SouthAfrica to an overseaaccount.First,I must solicit your strictest confidence in this transaction.This is by virtue of it's nature as being utterly confidential.... etc.

It goes on to say if you send some money, or your social security number, or something else to me I can get my money and I'll give you $1 million. This is clearly too good to be true and is an obvious scam. Don't ever get fooled by one of these.

However, these things can get trickier. Yahoo has been running ads for what as far as I can tell is a Ponzi scheme. The ads point you to A quick visit to the site reveals a somewhat official looking "financial" site. However, they make the following claims:

Our benefits:
- high profitable returns
- 2.66% per trading day for 15 days (2.66 x 15 trading days = 40% including principal)
- 90% in 3 weeks (including principal, profit payout will be made after 3 weeks) NEW!
- no administration fee
- customers privacy protection
- 10% referral program
- 24/7 tech support
- no statistic manipulation
- never missed a payment to our members
- daily payouts directly to your e-gold account
- all deposits secured and payouts guaranteed!

The 90% return in 3 weeks should clue you in that this is too good to be true. This is some kind of scam. I can't believe Yahoo could serve up ads supporting this, but a Google search for "gbxfunds" will bring up many instances of this particular scam. In my opinion, Yahoo should be responsible for screening out fraud ads like this or held liable when their "customers" are tricked by them.

A couple of general guidelines to NOT getting scammed are:

1) There is no such thing as get rich quick. There is get extremely lucky (win the Powerball, be a dot.comer, etc.) which you have very little chance of doing and then there is the alternative for the rest of us, working hard at it over a long period of time. If someone promises you will get rich quickly, the SCAMDAR should be going off.

2) If there is a guaranteed return much higher than treasury bonds (they are considered to be risk free), be very skeptical. The key here is guaranteed. Risk and return tend to go hand in hand. The higher the risk, the higher the return needs to be to justify an investment. If something is guaranteed it implies no risk so the return by definition ought to be low.

3) If there are outrageous returns promised, stay away. According to his most recent letter to shareholders, Warren Buffett has returned 21.6% annually for his investors from 1965-2006 as measured by the book value of his company Berkshire Hathaway. If the promised returns are significantly higher than this your SCAMDAR should start going off even if the return isn't guaranteed. Either someone is confident they are one of the best investors on the planet or they are taking an inordinate amount of risk to generate their returns. You probably don't want to get involved either way unless you really, really know a lot about what is going on with this particular investment.

So stay skeptical and keep your money!

Checking account has more than one month's expenses in it? You are wasting money!

Checking accounts pay notoriously low interest rates. For instance, my Wells Fargo account pays a measly 0.1% Annual Percentage Yield (APY) for up to $5,000 balances and a 2.75% APY for balances from $5,000-$100,000. Those rates just aren't very good! You should keep as little money as possible in your checking account (I find one month's expenses to be comfortable). As an alternative, I set up an FDIC insured SavingsLink account with Countrywide. This account pays 4.00% APY on balances less than $10k, 5.25% from $10k-$50K, and 5.40% for balances above $50k. The account is linked to my Wells Fargo account and allows me to transfer money back and forth with just a few clicks of the mouse and a two day lag typically. There are numerous other accounts out there, but Countrywide is paying the highest rates right now. In fact, the blog over at just detailed the highest paying accounts in this post. Rates tend to vary over time, so if you are reading this long after the original post you should check Bankrate for Money Market Accounts (MAAs) in the Checking and Savings section to compare rates. If you have $25k lying around for emergencies (and I do advocate having a little something stashed away), you will save $625 per year by keeping that money in a higher yielding online savings or money market account as opposed to in your checking account.

Sunday, March 25, 2007

Got loose change? Thinking of going to Coinstar? Forget about it. Save yourself 9%.

According to Coinstar's 10-K filed with the SEC Americans processed $2.6 billion worth of coins through their machines in 2006. Their typical transaction fee is an outrageous 8.7%! That means that Americans gave Coinstar a fairly hassle-free $226 million last year. Now not all of that went to Coinstar; they had to split some of it with the retailers that carry their machines and some also went to their gift card partners like Home Depot. But the reality is there is no reason for any of us to be paying Coinstar a single penny.
The Armchair Fiduciary has discovered a fantastic website called The Coin Counting Home Page. In Armchair Fiduciary-like altruistic fashion this kind individual has put up a site that includes cheap and or free coin counting machines locations in all 50 states. So stop paying outrageous fees to consolidate that loose change and get over to!

Saturday, March 24, 2007

Say NO to the Double Ding! ATM Fees and How to Eliminate Them Without Planning Your Life Around In-Network ATMs

I hate ATM fees. I shouldn't be alone. According to an article posted on Bankrate in 2005, 96% of banks were charging non-customers fees to use their ATM and 87% of banks were charging their own customers to use someone else's network. On average banks were charging people not in their network $1.57 to use their ATMs, while peoples' own banks were charging them $1.37 to use an ATM in someone else's network. This horrific "double ding" means that if you use an ATM at a bank outside your network, the majority of the time you will pay $2.94 on average for the privledge of convenience. Let's assume you are using an ATM outside your network once a month. Over 30 years that means the banks will take $1,058 of your hard earned money. Assuming you reinvested that money at an 8% return that is $4,382 that the banks are stealing from you one withdrawal at a time.
My personal experience was worse than this. My main checking account at Wells Fargo (which I love for a whole host of reasons, ATMS not being one of them) was charging me $2.00 to use non-Wells Fargo ATMs and because I was travelling so much for work I was using them up to three times per month. I decided that there had to be a better way. When I searched around on the internet there were plenty of articles that suggested planning your visits to the ATM better to avoid the fees. That option didn't hold much appeal to me since I was frequently arriving in a new city for work and having absolutely no idea where an ATM was, let alone one from Wells Fargo.
Then I found Umbrellabank. Umbrellabank offers a checking account called virtually free checking. The account requires $100 to open, but has no minimum balance requirements thereafter. It will reimburse you for up to $6.00 in fees charged by other banks to use their ATMs each month. Umbrellabank itself charges no fees to use non-network ATMs presumably since they don't have many ATMs of their own. I opened an account and keep about $300 in there. That way, when I am traveling, I can go to any ATM and I know that Umbrellabank will reimburse me. When I am at home, I still go to my Wells Fargo ATM, but with my Umbrellabank account I don't have to pay an arm and a leg to use a non-network ATM and I don't always have to plan to be near a Wells Fargo ATM.

Friday, March 23, 2007

Introduction to the Armchair Fiduciary

fi·du·ci·ar·y /fɪˈduʃiˌɛri, -ˈdyu-/

Law. a person to whom property or power is entrusted for the benefit of another. –adjective Unabridged (v 1.1)Based on the Random House Unabridged Dictionary, © Random House, Inc. 2006.

Welcome to the Armchair Fiduciary. In simple terms a fiduciary is an individual that represents the interest of someone else, a beneficiary, in matters of business. He (or she) basically has a legal duty to always do what is best for the beneficiary's interests without profiting from it (unless the beneficiary approves it) and while avoiding conflicts of interest in the process. Unfortunately, unless you have a trust fund which pays all your bills, you probably don't have a fiduciary for your personal finances. When it comes to figuring out how best to navigate the ever tumultuous waters of credit cards, mortgages, insurance, 401ks, etc. most of us are in a lifeboat by ourselves. With this blog, I hope to change that one post at a time and to help you navigate safely towards your financial goals (or at least throw you an oar so you can stop paddling with your hands).

I basically plan to do two things on this site. First, I will share with you how I manage my own finances and pass on as many "good deals" as I can find. Second, I will respond to your comments and/or emails and tell you what I would do if I were in your situation. Why, you might ask, are you doing this? There are several reasons. First, I pick stocks for a living so while I can have a direct impact on our investors wealth, I rarely get to pass on what I know about broader financial issues to them. The Armchair Fiduciary is my chance to be an educator which seems like a great thing to do. Second, I hope I will learn from my readers' experience and comments. I will definitely learn from your questions as I am sure I will need to do plenty of research to answer some of them. Third, I feel like my writing skills are starting to get a little rusty and this blog will force me to keep them sharp and hopefully improve them significantly over time. Finally, if this blog is wildly successful I have every intention of leveraging Google's AdSense platform to generate some extra income. I'm not holding my breath for this one, but if I am going to be your armchair fiduciary there had better be full disclosure from the beginning.

So why on earth are you qualified to be a fiduciary you might ask? The short answer is I'm not. I am not a financial planner nor do I offer professional financial advice for a living. Hence the "armchair" moniker is fully appropriate and it should be duly noted that all advice given here is merely the opinion of the author. However, I have always loved all things finance. I received my first share of stock (Walt Disney) as a gift when I was 12 years old. It was fantastically cool to think that my one share represented part of the company. Maybe it was some executive's desk, or some illustrator's colored pencil set, or as I imagined when I was a 12, maybe I owned a trash can at Disney World! The whole thing fascinated me and from that time I was hooked. This finance thing was for me! So I spent a lot of time reading about stocks and mutual funds and all things financial. I then marched off to an Ivy League school and studied economics. From there I went on to work for a large mutual fund as an equity analyst and now I work at a hedge fund. Along the way I earned my Chartered Financial Analyst (CFA) designation. I am still a young lad in my late 20s, but personal finance is one of my passions and I would be honored if you would let me share it with you. So sit back, relax, and get ready for the Armchair Fiduciary!