Republican, March 27, 2005 D15 THE WALL STREET JOURNAL SUNDAY. But opening an individual retirement account now, when you're under 30, will put you in another league when you're 65. The two main types of IRAs: traditional and Roth. The traditional gives you a tax break on your next year's return but you pay taxes on all withdrawals. A Roth, on the other hand, gives you no tax break now, but the money grows tax-free through the end of your life and sometimes beyond.
For young adults especially, Roths are generally the best choice because the money has longer to sit in the account and earn interest that will never be taxed. Even if you invest in an employer 401(k), Roth IRAs have advantages. You can pick any investments you want, for one, and your earnings grow tax-free versus just tax-deferred. Several investment firms including Vanguard (www.vanguard. of next year, you can contribute $4,000 more, for 2005.
Suppose you take that $1,000 refund and invest it in a Roth IRA tomorrow. And let's assume you put the money in a life fund, such as Fidelity's Freedom 2040 fund, that has an investment mix targeted to your expected retirement date. If that fund earns, say, an average return a year -a fairly safe bet- -you'll have turned that $1,000 into $1,500, a return, after seven years. Better yet, if you put that $1,000 refund into the IRA every year, you'll have about $7,000 saved after five years. If you're desperate, you can always withdraw your contributions to a Roth penalty-free.
But then you'll risk hurting your long-term retirement savings. Here's why starting your retirement fund early is so smart: If you start contributing $1,000 a year at age 25, you'll V. have about $155,000 money in investments like stocks, since the prices can swing so much that you can't guarantee a positive return in just a few years. So most financial advisers suggest putting home funds into short-term bond mutual funds or other safer investments that won't penalize you for tapping them after a couple years. Perhaps you can put the money into two-year certificates of deposit, which now yield an average 3.5%, according to Bankrate.
com. That's not so shabby when you consider that stocks might return only a year or so -and that's before investment costs. That $1,000 refund you put into a CD would gain about $70 (before tax) after two years. And maybe you'll add in next year's refund, too. Starting Out By Kelly K.
Spors Rather Than Spend Your Tax obody's short ideas for saved up by age 65, assuming a how to spend their tax re- Do the Math return. However, a 40-year-old fund. A look at how you can put a $1,000 tax refund to work would need to contribute $2,825 a But this year, before you go over five years. year- -almost three times that blow it on an iPod or some similar 1 amount- -to reach that savings temptation, consider doing some- Pay off credit card: 3 level by 65. thing that will change your future- Pay off $1,000 on APR credit card, and your financial -for assuming minimum monthly payment.
Save for a Home years The to 18 million or so tax 5-year savings $779 come. filers Let's be real: When the time between the ages 18 and 24 earn an Open a Roth IRA: comes, will you have a big stack of average refund of $939, according cash sitting around to make a to the Internal Revenue Service. $1,000 put into life-cycle fund with down payment on a home? And that's likely to be a little' average annual return. While now might be a risky higher this year. 5-year return $338 (tax free) time to plunge into home ownerSo let's assume you've got a ship, because housing prices have $1,000 refund coming your way.
Start a down-payment fund: climbed to record levels in many What could you possibly do with areas and rising interest rates that kind of lump sum? $1,000 into 5-year CD with 4.1% could potentially dampen prices, interest rate that compounds daily homes are often the best investPay Off Plastic 5-year return $228 ment many people ever make. $1,000 into short-term bond mutual But in order to buy a home, you This is one of the only surefire fund with average annual return usually need to make some sort of ways to guarantee a fantastic in- 5-year return $276 Klug down payment. Traditionally, vestment return. Dave home buyers put down. Now, If you put that $1,000 toward Sources: CardRatings.com; Bankrate.com; Morningstar Inc.
many mortgage lenders' offer paying off your credit card with loans for as little as to the worst rate, you're saving your- your credit score and hurt your com) and Fidelity (www.fidelity. down. Still, if you're buying a self maybe $150 to $200 a year that chances of qualifying for decent com) have Roth IRAs that you can $200,000 condo, that's a solid would have been spent on interest mortgage loans, auto loans and set up from their Web sites. Fidel- $10,000 to $20,000 investment. (Also if you make the minimum monthly personal loans.
ity will take a starting investment allot a few thousand dollars in clospayment. That's a to re- Convinced yet? of as little as $200. (If you're really ing costs and other fees.) turn! (A brain-tickler: Try to find ambitious you can even get regu- Starting a home-buying fund is that kind of return in the stock Open a Roth IRA lar deposits made from your bank a good way to make sure you have market right now.) Multiply that account.) Through April 15, you down-payment money when you acover the course of five or six years, OK, most investments can't can contribute up to $3,000 to an tually are ready to buy a home. and you're talking about a beat paying off your credit cards. IRA for 2004.
And through April 15 It's usually best not to keep that return. With so many cards nailing you with annual rates of or more, credit cards are by far the most dangerous debt most twentysomethings have. They also carry personal risks, which is why you're doing yourself a giant favor by erasing that debt as quickly as possible. Many credit-card companies reserve the right to jack up your rate to almost if you amass too much debt or pay any kind of bill late. Not to mention the $25 to $35 in finance charges they'll hit you with every time you spend over your limit or mail in a bill a few days late.
With these kind of terms, you could soon be drowning in debt. And credit-card goofs can have long-term consequences. Anything that goes wrong with your credit card is likely to show up on your credit report and stay there for seven or more years. It can trash MarketWatch By Paul B. Farrell Tip for Retirees: Fire Broker, Save Big 1 ongratulations, you're a disciplined investor who is on track to retire with a milliondollar nest egg.
And you want the absolute maximum from your hardearned money. Here's the secret that could boost the cash in your pocket by as much as in retirement: Kiss your high-cost broker or financial adviser goodbye, and manage your own money using low -cost index funds. Let's assume you're retired with a million-dollar portfolio. Experts say you can comfortably withdraw of your total each the first year- -and still make it last a lifetime, thanks to the offsetting growth in the remaining money. 4 You may have other income, Social Security and a pension.
And you may have taxes. But in this example, we'll assume you're just living on $10,000 in after-tax money. Consider the cost of two choices for managing your portfolio: Option. Hire a broker or other 1 financial adviser who charges a percentage. Suppose you turn your million bucks over to a third-party adviser.
You'll typically be charged a management fee of to of your portfolio value annually. Let's assume your adviser agrees to a fee: $10,000 every year for managing your hard-earned million dollars. Option Self-manage using in- 1: dex funds. If you're managing your own money, you save that $10,000 a year and can invest or spend it any way you choose. Notice: Even though a fee doesn't sound like much, this $10,000 is of your annual $40,000 withdrawal -a high price to pay for something you can do yourself.
Even better, using Option you also get to pick all the funds in your portfolio. So forget the actively managed funds that most portfolio advisers would probably put you in. Build a well-diversified portfolio of low -cost index funds (either mutual funds or the exchange-traded kind). Funds' Big Cost Gap Why use market index funds? Because the operating expenses of the best of these are much lower than on actively man- SmartMoney By Aleksandra Todorova Cash Accounts Rebound ash-based accounts -certifi- Historically, money funds have ket cates of mutual deposit, funds and money-mar- sav- beaten percentage savings point. accounts Now with by a rates full tings accounts -may finally be on the rise, this pattern is starting worth a look again.
to get back to normal. Since the Federal Reserve "You're looking at a fed funds started raising rates last June, the target in the range of about by federal funds rate has jumped to year' end," says Peter Crane, vice 2.75% from (counting Tuesday's president and managing editor of quarter-point increase). As a re- iMoneyNet's Money Fund Report. sult, the average annual yield on That means money funds should be money-market funds has gone to just under 3.5%. (Money funds typi2.05% as of March 22, from 0.75% a cally lag the fed funds rate by about year ago, according to iMoneyNet.
half a point, to cover expenses.) com, an industry tracker. One- Pros: Liquidity, since many year CDs with a $2,500 investment funds offer check-writing capabilnow pay 2.36%, compared with ity. Interest rates catch up with the 0.95% this time last year, accord- fed funds rate faster than moneying to Informa Research Services, market savings accounts. based in Calabasas, Calif. And in- Cons: These funds aren't federvestors can now find annual rates ally insured and can lose value.
of or better on money-market savings accounts if they're willing Savings Accounts to go with an Internet bank. While the yield on most savings Here's a rundown of the options: accounts remains anemic at best, Certificates of Deposit ing you can Internet do banks, significantly which, better these usShorter-term CDs offer lower days, are paying as much as 3.25%. yields than their long-term counter- Internet banks can afford the parts, but as interest rates go up higher yields because they don't and the CDs mature, investors can have the overhead expenses of manreinvest the money at better rates. aging bricks-and-mortar branches. "I wouldn't recommend that You open an account online, but people go past 12 months," says must handle all withdrawals or deMarilyn Bergen, a certified finan- posits through an existing checking cial planner and owner of CMC Ad- account with a traditional bank.
visers in Portland. Ore. She ad- You can move funds back and forth vises splitting money between six- between accounts online. Some month and 12-month CDs. banks have both traditional and onMany banks are spicing up line divisions, like the 155-year-old their CD offerings with special fea- Emigrant Savings Bank in New tures that let you raise a CD's in- York, which earlier this year terest rate before it matures, says launched an online division, Randy Rosen, manager of deposit EmigrantDirect.com.
In other cases, research at Informa Research Ser- you'll have to go through a different vices. These are often called bank. For instance, if your checkbump-up CDs, though some banks ing account is with, say, Citibank, have other names for them. you could open an Internet savings Pros: Rates are typically higher account through INGDirect.com. than those of money-market funds Pros: Low or no fees; small minor money-market accounts.
imum investment requirements; Cons: Money can be locked in high interest rates. at a fixed rate that might not keep Cons: No bricks-and-mortar up with rates offered elsewhere. branches. And many banks limit Money must be invested in fixed withdrawals to six per month. increments.
(For more information on these Money-Market Mutual Funds three offerings, savings go to vehicles and www.smartmoney. specific Last year, money-market mutual on the Web.) funds were the black sheep of shortterm investments: They earned as Aleksandra Todorova writes for little as 0.50%- a yield available on SmartMoney.com. You may send an ordinary savings accounts. e-mail to: "Getting Going" by Jonathan Clements will return next week. For comments on "Starting Out," write to: forum.sunday03@wsJ.com Who Has Other Ideas for Social Security? aged funds, saving a lot.
The math is simple: Actively managed stock funds have average annual costs of almost 1.5% of assets. But index funds have expenses closer to 0.2%. That gap of 1.3 percentage points could cost you an extra $13,000 a year if all your money's invested in actively managed stock funds rather than index vehicles. Ouch, That's a Lot Add in the $10,000 management fee and that's $23,000 paid to your adviser and fund managers. It's only 2.3% of your million-dollar portfolio- -but equal to of your planned $40,000 withdrawal.
Financial advisers will argue that their services are worth the extra you'll pay them -especially if you don't have the time, experience or inclination to handle finances, or might panic and bail out of a long-term investing plan. They'll tell you they can pick actively managed funds that will beat your index portfolio. Of course, they'll have to beat it by $23,000 or more each year. If not, you'll have to live on less money. Or you'll have to withdraw more each year, and deplete your nest egg faster.
Market's Hard to Beat Alas for the advisers, history suggests that many are unlikely to succeed. Between and of actively managed funds fail to beat their indexes, and those that do aren't consistent winners. On the other hand, the expense ratio is a valid predictor of future performance. A study conducted by Boston-based Financial Research Corp. a few years ago concluded that lower operating expenses "deliver above-average performance across all time periods," while all other factors, including star ratings, had little or no predictive value.
How to Help Yourself So what's the next logical step if you decide you're going to manage your own portfolio? Build a lazy, indexed portfolio. like the strategy mentioned in the spring issue of the "Coffeehouse Investor" newsletter (www. coffeehouselnvestor.com/spring05. htm). The Coffeehouse portfolio allocates to stocks and to bonds.
The stock part is divided equally into six asset classeslarge-capitalization; value; smallcap; small-cap value; international and real-estate investment trusts. The bond part is an intermediate-term bond fund. Using Vanguard index funds to meet those goals, the portfolio generated a 14.2% return in 2004, the newsletter says. More impressive, in what has been a rough investment climate over six years through 2004, the seven-index-fund portfolio generated an annualized return of 7.9%, beating the Dow Jones Industrial Average total return of 4.7%. After looking over these numbers, you may still want to keep your financial adviser for other reasons.
But before you do, think about that $23,000. Paul B. Farrell writes for MarketWatch (online at www.marketwatch.com). E-mail: Last Call for Stock Contest you were waiting for the last darts at the stock listings in the I possible moment to enter our newspaper. The best performer 19th Sunday Journal investment among the six reader selections dartboard contest, will win a Sunday Journal tote bag it has arrived.
and lifetime bragging rights. Today is the last Here are the rules: day you can name Choose a stock that you think your favorite stock, will do well in the next six months. for the six months Include your name, address, day through September phone number, e-mail and name of by sending an e-mail to local paper where you read Sunday Journal. No entries by regular mail. Six reader picks chosen at ran- Financial pros can't enter, nor dom will compete with six hit by can our prior contestants.
You must Sunday Journal staffers tossing be willing to be interviewed. d. resident Bush's proposals for Social Security have been met with strong opposition, even though he hasn't yet outlined an actual plan. So does anyone have other ideas? In fact, IN more than a half dozen ReTRANSLATION publicans have trotted out alternatives--some in reaction to early criticism of what's known about the president's proposal. First, Mr.
Bush's proposal so far: Workers under 55 could divert up to a third of the 12.4% payroll tax, up to $1,000 annually, into a retirement account to be invested in a government administered menu of stock and bond funds. In return, they would agree to reduced traditional benefits in retirement. Meanwhile, the U.S. would borrow trillions of dollars to pay current beneficiaries. Because the accounts wouldn't address Social Security's solvency, Mr.
Bush has said he's open to cutting future benefits and even raising the cap on wages subject to payroll taxes. Carving out the personal accounts by far has drawn the most opposition. Sen. Orrin Hatch Utah) and. Rep.
Clay Shaw Fla.) have plans that would have the government subsidize creation of "add on" accounts on top of Social Security, relying heavily on borrowing. Sen. Robert Bennett Utah) would delay introduction of private accounts, while focusing on making Social Security solvent. Here are some other ideas being floated: Rep. Jim Kolbe Ariz.) and Rep.
Allen Boyd only Democrat signed on to a private accounts plan would have mandatory accounts for all workers under 55, with government matches to encourage low- and moderate-income workers' added savings. It would hasten current law's phased increase to 67 in the eligibility age for full benefits, and raise the cap on taxable wages. Sen. Bennett would change the calculation of initial retirement benefits from the current index linked to wage growth, to one that is tied to prices, which generally rise more slowly than average wages. Because that would greatly reduce benefits over time, Sen.
Bennett suggests that the bottom of income earners continue to have initial benefits linked to wages, benefits for the top be tied solely to inflation, and, for the rest, that there be a graduated blend of wage and price indexing. Sen. Chuck Hagel Neb.) would let workers under 45 direct of wages (about a third of Social Security payroll taxes) into personal accounts. He would raise the full-benefits eligibility age to 68, index retirees' initial benefits for longer life expectancies and reduce the already-lower benefits for those who take early-retirement benefits at 62. Sen.
Hatch's proposal for retirement accounts that are separate from Social Security would provide a federal match for workers' own savings of up to $1,000 a year, geared to be most generous to lower-income workers. Additional federal payments would go to those who agree to postpone receiving traditional Social Security benefits for five or 10 years. He would also support raising the wage limit for payroll taxes. Sen. John Sununu N.H.) and Rep.
Paul Ryan Wis.) would have workers divert about 6.4% of wages, and guarantee them a minimum retirement benefit should their accounts- combined with their reduced Social Security paymentsfall short of that minimum. It would rely on government borrowing and big cuts in other federal spending over time. By Jackie Calmes Rent vs. Buy Becomes a Closer Contest ent or buy? That's become a tougher call for potential home buyers in many areas. Traditionally, home prices and rents moved in alignment.
But the gap between the cost of renting and owning has widened in some PERSONAL BUSINESS cases, particularly in hot housing markets. Behind the change: low rates and new mortgage products have helped turn many renters into homeowners. That has boosted home prices--and, in turn, has prompted landlords to cut rents or raise them less aggressively. The result is that the gap between the cost of renting and the cost of buying in some markets is at its biggest since at least 1994, according to Torto Wheaton Research in Boston, and by some accounts at its biggest since the 1970s. The data suggest the economic case for renting, at least in the short term, has grown significantly in these markets.
Since 1999. and 2000, the rela- 1 I tionship between rents and home prices has "broken down," says Mark Zandi, chief economist of Economy.com. In Washington, D.C., rental costs are now just of the cost of owning, down from in 2001, according to an analysis of 21 key markets prepared for The Wall Street Journal by Torto Wheaton. In Miami, rental costs are of the cost of homeownership, down from in 2001. (Properties in the survey may not be directly comparable, but the analysis shows how the relationship between renting and owning has changed over time.) The potential cost savings for renters could be even larger, given that the analysis doesn't factor in property taxes and other homeownership expenses.
Mitigating that is the fact that mortgage interest and property taxes typically are deductible from federal income taxes. Homeowners often can deduct interest and real estate taxes on their state and local tax returns, too. Despite the lower comparative cost of renting, the lure of homeownership -coupled with the fear of missing out on price appreciation and being shut out of the market for good -still push many people to buy. The rate of homeownership in the U.S. was 69.2% in the fourth quarter of 2004, compared with 67.5% in 2000.
Many buyers are betting that rents eventually will rise and that any savings from renting will be more than offset by rapid gains in home prices--a pattern that has been true in recent years. Still, many economists say those outsize gains may become a thing of the past as interest rates move higher. Whether renting or buying is the best move depends on factors including how long you expect to stay and whether what is on the market to buy or rent meets your needs. By Ruth Simon and Ray A. Smith JOURNAL LINK: To see how the WS.J ratio between renting and buying a home has changed in 21 major markets, see the Personal Business article at http://WSJ.com/sunday arc.
