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7 retirement planning myths debunked

If you ever plan to retire, you have to have a plan. The days of depending on an employer pension and government benefits are rapidly disappearing and, especially if you are under 50, you are living in a “yoyo” economy — short for “you’re on your own.”

There are a bunch of myths about retiring that need to be abandoned.

It’s OK to postpone saving for retirement until other needs are taken care of. Wrong. There are always “other things” that interfere with saving for retirement and if you let them get in the way, you’ll never start.
Medicare will take care of almost all your health care needs. In reality it will cover about half.
You’ll need far less income in retirement to maintain the same standard of living. Only if you decide to become a hermit.
You can claim Social Security early and still get full benefits later. Wrong. When you begin taking benefits you are locked in (unless you pay it all back).
You should rely heavily on bonds rather than stocks as you get older. Only if you plant to die soon and expect zero inflation.
Any retirement target-date fund will allow you to “set it and forget it.” Target date funds vary widely in performance and there are no guarantees associated with them.
You’ll be able to make up a savings shortfall by retiring later or working part-time in retirement. That’s a hope, not a plan. You may not be physically able to work after retirement. Because of the costs of benefits, many employers are reluctant to hire older workers.

A plan is needed, and needs to be constantly updated to keep you on the path to the kind of retirement that you want.

Open a Roth IRA for Minors

Consider this example: If a child invests $2,000 in a Roth IRA each year from ages 13 to 17, that $10,000 could increase in value to almost $296,000 by age 65, according to research by T. Rowe Price. That assumes the account earns a 7% annual rate of return. If that panned out, the account could provide tax-free income of $11,800 a year for 30 years.

Tax-free compounding of earnings inside an IRA is a beautiful idea — and a powerful one. The longer you can keep your money invested in a tax-free vehicle, the greater your wealth accumulation. What better way to accumulate a large amount of savings than to start during childhood? When tax-free compounding has more than 50 years to run its course, a relatively modest savings plan can produce substantial wealth.

There’s no minimum (or maximum) age to set up a Roth IRA. And there’s no requirement that the same dollars that were earned be used to fund the IRA. If your child earned money on a summer job and spent it on whatever kids spend money on these days,* there’s nothing wrong with using money provided by parents to establish the IRA. The child has to have earned income, though.

The major impediment to IRAs for children, especially young children, is the earned income requirement. An unmarried person must have earned income of his or her own to contribute to a Roth IRA. The income has to be compensation income, not investment income. And it has to be taxable compensation income.

That doesn’t mean your child has to actually pay tax on the income. If the total amount of income is small enough so your child doesn’t have to pay tax, that’s okay. But your child has to have the kind of income that would call for a tax payment if the amount were large enough.

You’re never too young to start thinking about retirement.

For most 20-somethings, the idea of retirement isn’t front and center. It isn’t even a glimmer. But it ought to be. This is especially true for young people today, many of whom believe that Social Security will not be there for them when they retire. When you’re young the most valuable resource you have is time.

Time provides you with the power of compound interest. Albert Einstein called it the “greatest invention of all time. ” For example, a 25-year-old who starts saving just $600 a year could have $72,000 at age 65, nearly twice as much as someone who saves $1,200 a year beginning at 45, according to calculations by LearnVest, an online financial-planning service.

Retirement may be 40 years away, and your paycheck may small, you may have rent to pay and student loans to pay off, but saving even small amounts early on can make a big difference. Many employers offer 401(k) plans that offer a company match, which is “free money” to the employee. The money grows tax deferred, or if it’s a Roth plan it grows tax free. These plans are often among the single biggest pools of funds that people have to draw on when they retire. If you don’t work for a company that offers some kind of a retirement plan, start your own by contributing to an IRA or a Roth IRA. The best time to begin was yesterday, the second best time it today.

Women and disability risks

One of the biggest financial risks that people face is the risk of becoming disabled and not being able work for a considerable time. The Social Security Administration estimates that one in four of today’s 20-year-olds will be disabled before they retire.

In 2005, 47.5 million adults (22{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} of all adults) reported a disability.

Women are more likely to be disabled than men.

Work related injuries represent less than 5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} of disabilities. According to the CDC (Centers for disease control) the primary problems are musculoskeletal disorders, and the number one cause is arthritis followed by back & spine problems. Women are twice as likely to be disabled by arthritis as men.

Disability insurance is something that every working person should consider.

Tools for getting out of debt

Getting out of debt is easy, stop spending and pay off your bills. The overweight person gets very similar advice: eat less and exercise. They are both pieces of good advice, but they rarely work all by themselves because we are creatures of habit, whether it’s spending or eating. So here are my twin tools for helping you with the debt issue (for the dieting part, you’re on your own.)

First, get a copy of Dave Ramsey’s book “The Total Money Makeover.” It’s a virtual 12 step process designed to get you debt free and build wealth. The book costs about $25.00 and is worth every penny. Dave Ramsey has built a business around personal finance advice that includes books, a radio program and courses that are being offered throughout the country. The course is offered by many churches and is both entertaining and filled with outstanding information.

Second, if you have a computer, get a copy of “Quicken.” It is the number 1 selling personal finance software. If you are in debt you have to know where your money is going before you can fix your problem. Quicken allows you track every penny that you spend. In addition it makes balancing your checkbook a snap and has other features that are useful once you begin to accumulate wealth. The program costs less than $50.

What is an asset class?

Financial professionals constantly talk about asset classes, but what does that mean? In the broadest sense, asset classes refer to a group of securities that have similar risk/return characteristics. So, for example, in the broadest terms, stocks, bonds and cash represent the three most common asset classes. Each has different risk and return characteristics and behave differently in response to a variety of economic and political events. Stocks react most to corporate profitability, bonds to interest rates and cash to inflation. That does not mean that these are the only issues that these assets react to but they are the predominant ones.

Most managers divide these broad assets classes into subgroups that act differently at different times. Stocks, for example, can be divided into large cap, small cap, foreign or domestic. Bonds can be subdivided into government, agency, municipal, corporate, foreign or domestic. These classes can be divided again into their own subgroups. The challenge for the investor is to find ways of participating in these investments. This is where the expertise of the professional investment advisor comes into play.

Why is this important? Because investment management is often about risk control and this is often achieved by balancing various assets classes to achieve the degree of risk to which a portfolio is subjected. Modern portfolio theory demonstrates that investment with low correlation to the rest of the portfolio can lower over-all volatility even if the underlying investment itself is volatile.

The risks of bond investing.

For many investors, bonds are more mysterious than stocks. Most people know that a bond is a loan and you are the lender. Who’s the borrower? Usually, it’s either the U.S. government, a state, a local municipality or a big company like General Motors. All of these entities need money to operate — to fund the federal deficit, for instance, or to build roads and finance factories — so they borrow capital from the public by issuing bonds.

There are several risks that you take when you buy a bond (or to put it another way, lend your money).

The first risk that you need to be concerned about is “credit risk.” This is the risk that the bond issuer (the borrower) can’t pay the interest or principal back. You may know how that works if you lend money to a friend. It works exactly the same way in the bond world. If a bond issuer can’t pay, the bond is said to be in “default.” At that point you cannot be sure if you will get any of your money back.
A second risk with bonds is known as “interest rate risk.” When a bond is issued it has a stated interest rate which is usually fixed for the life of the bond. If interest rates go up during the bond’s lifetime, the value of the bond will go down. If you need to sell it during this time you may get back less than you paid.
A third risk is the erosion of your “purchasing power.” When you buy a bond, your money has a known purchasing power. As an example, you know that you can get a cup of coffee at most places for about $1.25 (more at Starbucks) . If you buy a bond that does not come due for 30 years you can be fairly sure that that same cup of coffee will cost a lot more due to inflation. Yet if you buy the typical bond for $1000, you will get back $1000 at maturity and that may not buy nearly as many cups of coffee. That lost purchasing power needs to be offset by the interest payment you receive.

This is a greatly simplified discussion of bond risk, but it gives you a starting point to try to determine how bond investing should be viewed.

What is an IPO?

An “IPO” or “initial public offering” is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.

An example if the recent offering to the public of the common stock of Facebook. This company was private until it decided to offer it shares to the general public and allow itself to be traded on a major exchange. From Investopedia.

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market.

The benefit to the founders of the company is that it gives them the ability to sell part of their stake in the company to the public, often making them millionaires or even billionaires overnight. It also provides the company with much more capital than it previously had for purposes of expansion and growth.

The benefit to the public is their ability to participate in the company’s growth alongside the founding shareholders.

IPOs should be viewed with a great deal of caution.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values.

Investors in the IPO of Facebook found this out when the excitement and hype surrounding its initial offering resulted in such a demand for the stock that people were willing to pay much more for the stock than was warranted.

What is a short sale?

Today, people generally think of a “short sale” as a real estate transaction in which the home owner sells his property for less than the mortgage. Before the housing crisis, “short sale” referred to a transaction in the stock market. So what does it mean when we sell a stock “short.”

Borrowing a security from a broker and selling it, with the understanding that it must later be bought back (hopefully at a lower price) and returned to the broker.

Short selling (or “selling short”) is a technique used by investors who try to profit from the falling price of a stock. For example, consider an investor who wants to sell short 100 shares of a company, believing it is overpriced and will fall. The investor’s broker will borrow the shares from someone who owns them with the promise that the investor will return them later. The investor immediately sells the borrowed shares at the current market price. If the price of the shares drops, he/she “covers the short position” by buying back the shares, and his/her broker returns them to the lender. The profit is the difference between the price at which the stock was sold and the cost to buy it back, minus commissions and expenses for borrowing the stock.

But if the price of the shares increase, the potential losses are unlimited. The company’s shares may go up and up, but at some point the investor has to replace the 100 shares he/she sold. In that case, the losses can mount without limit until the short position is covered. For this reason, short selling is a very risky technique.

What is an option?

An option is a contract to buy or sell a specific financial product officially known as the option’s underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. And it has an expiration date. When an option expires, it no longer has value and no longer exists.

Options come in two varieties, calls and puts, and you can buy or sell either type. You make those choices – whether to buy or sell and whether to choose a call or a put – based on what you want to achieve as an options investor.

Options can be used to generate added income from securities, like stocks that you already own. The most common of these are “covered call options.” They can also be used as a temporary insurance policy against a decline in the price of a stock or the market as a whole. The most common of these are known as “protective puts.”

Options are complex instruments that require a sophisticated understanding of securities, and while some options can be used to reduce risk, others can create large amounts of risk.

What is a municipal bond?

Municipal bonds are debt obligations issued by states, cities, counties and other governmental entities, which use the money to build schools, highways, hospitals, sewer systems, and many other projects.

When you purchase a municipal bond, you are lending money to a state or local government entity, which in turn promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date. Most municipal bonds can be redeemed prior to maturity. This is a date specified in the “Offering Statement” and is known as the “Call Date.”

Not all municipal bonds offer income exempt from both federal and state taxes. Most states exempt the interest paid by municipal bonds issued by entities within that state but tax interest earned on bonds from other states. There is an entirely separate market of municipal issues that are taxable at the federal level, but still offer a state—and often local—tax exemption on interest paid to residents of the state of issuance.

Municipal bonds are issued in denominations of $5000. Most investors in municipal bonds buy them on the secondarily market. The actual price paid for a bond may be either more or less than “par” which is defined as 100 cents on the dollar. The stated interest on a bond is referred to as the “coupon” rate. Bonds are priced so that bonds of equal quality with the same maturity (or call) date have the same yield to maturity.

The municipal bond market is a specialized market and requires an in-depth knowledge of issuers, quality, yields and prices.

What is a dividend?

Experienced investors know all about dividends but we thought it would be a good idea to explain dividends to newer investors. And perhaps even experienced investors can learn something new here.

A dividend is money that corporations pay our to shareholder. Older, established US companies will pay dividends to shareholders based on what they expect to be able to pay on a regular basis. Dividends are usually paid out quarterly, although there are exceptions and investors should be aware of that. American companies try to maintain the same dividend from quarter to quarter even if earnings fluctuate. Many raise the dividend as they become more profitable. This is not the case for foreign corporations whose dividends can be irregular and based on the profit for the quarter or the year.

Not all corporations pay dividends. Most corporations in their start-up phase use their income to invest in the business for growth. Shareholders in these growing businesses are rewarded by watching their stock price appreciate if the company is successful. But after a while a company will reach a limit on its rate of growth and decide to reward its shareholder with a steady income. There are some issues with dividends however and they have to do with the tax treatment of dividends that differ from the tax treatment of capital gains.

Unlike interest payments to bondholders, corporations cannot deduct dividends as a business expense. For this reason, corporations pay out dividends from after-tax profits. When a stockholder receives a dividend, he also owes taxes in the dividend income. For this reason, dividend income is generally considered to be taxed twice, one at the corporate level and once at the individual level. For example, if a corporation earns $100 it can be taxed up to 39.2%. That leaves $60.80 that can be sent to shareholders as a dividend. If all of it is distributed as dividends, the maximum tax rate on qualified dividends is currently 15%, leaving the shareholder with $51.68. Next year the special 15% rate will be repealed exposing your dividend to a maximum of 43.4%, tax, leaving you with $34.41. Of course these rates apply only to the top tax brackets but they do illustrate how taxes can affect what people have left to spend and why they change their behavior to avoid excessive taxation.

There are a few other things that investors should be aware of when investing in dividend paying stocks and that has to do with dates. A corporation will announce its dividend on one date. It wil also announce what is known as the “ex-dividend date.”

A stock’s ex-dividend date is the first day an owner can sell the stock without losing the rights to its upcoming dividend. Obviously, it’s also the first day a buyer who purchases the stock will not receive that same dividend. A good way to remember how the ex-dividend date works is to think of it as a synonym for “without dividend.”

A third date is the “pay date” which is the date on which the shareholder actually receives the dividend.

Category: Education