Investment

2 Investing Concepts Everyone Should Know

Matt Bell — Thu, 16 May 2013 10:36:31 +0000

Investing is arguably the most complicated and intimidating topic within personal finance. Understanding (and making use of) two key investing concepts will go a long way toward demystifying the process while dialing down the fear factor. Let's get started! (See also: The 10-Step Staircase to a Comfortable Retirement)

Compound Interest

At first glance, this one seems like no big deal. Compound interest is simply interest earning interest. For example, if you invest $100 and are able to earn 10% on that money, in a year it will have turned into $110. The next year, assuming you are still able to earn 10%, it isn’t just the initial $100 that earns interest, but the interest you earned last year will earn interest as well. So, you won’t end up with $120 at the end of year two; you’ll end up with $121.

Okay, so it’s not that impressive. But wait. Let’s put more money to work and give it more time.

Imagine investing $200 per month for your retirement beginning at age 20. And let’s assume you can get a 7% return on that money. By age 30, you will have invested $24,000. That’s $200 per month for 10 years. However, because of the 7% return, your $24,000 will actually be worth $34,617. Not bad, right? You racked up more than 10 grand in interest in just 10 years!

Don't Stop Believing

But wait. The longer you give it, the better it gets. Let’s run this all the way out to age 70, which, let’s face it, will probably be considered "early retirement" by then.

The $200 you’ve been dutifully tucking into your 401(k) plan all that time adds up to $120,000, an impressive amount unto itself. But because of the power of compound interest, that sizeable sum has become much, much more sizeable. In fact, it’s now worth more than a million bucks. Now that’s impressive. You’ve earned about $970,000 in interest through the power of compound interest.

This is why Albert Einstein reportedly called compound interest "the eighth wonder of the world." Even if he didn’t say that, it doesn’t take a Nobel prize-winning scientist to understand that compound interest is a relatively powerful concept.

Speaking of Einstein, there's a complicated looking formula for calculating compound interest. It's actually pretty straightforward once you understand the terms.

Even better, here's an online tool that calcualtes it for you.

On a side note, this is exactly why it takes so long to get out of debt. Debt takes the strong wind of compound interest and flies it in your face. Keep the wind at your back by investing.

“Fair enough,” you say, “but where can I get a 7% return?”

Asset Allocation

Pick up any personal finance magazine and you’re likely to see breathless headlines about the latest mutual fund to rack up impressive returns. But you’re not fooled. You realize that last month’s hot performer might be tomorrow’s dog. So which fund will do well next month?

Surprisingly enough, generating a respectable return on your investments isn’t so much about the specific investments you choose. It’s how you spread your investment dollars around. This is known as asset allocation. It may have a boring name, but asset allocation has been found to account for about 90% of investment returns.

Choosing Between Stocks and Bonds

The key asset allocation decision is what percentage of your investment dollars to put in stocks and what percentage to devote to bonds (or stock-based and bond-based mutual funds). Stocks are riskier than bonds, but they have the potential to earn a higher return. In general, the younger you are, the more your investment mix should tilt toward stock-based investments, but your risk tolerance matters as well. You can find lots of free asset allocation calculators online.

The calculators will typically suggest something a bit more detailed than stocks vs. bonds; they may recommend that you devote different percentages of your money to large-cap stocks (the stocks of large companies), small-cap stocks, foreign stocks, and bonds. Most brokerage houses, such as Fidelity, Vanguard, Schwab, and others, offer index mutual funds in these categories, which can provide a low-cost, relatively simple way to invest in those categories.

So, those are two key steps toward becoming a knowledgeable, successful investor. First, make use of the power of compound interest by getting started with investing as early as possible (although it’s best to wait until you’re out from under any credit card or vehicle debt and have a base of savings totaling three to six months’ worth of essential living expenses). And second, base your investment decisions on an intentional asset allocation plan that’s tailored to your age and risk tolerance.

What are your key investment concepts?

Written by Matt Bell and published on Wise Bread. Read more articles from Wise Bread.

7 Investing Lessons From the Two Comma Club

Darren Wu — Wed, 08 May 2013 10:36:32 +0000

When’s the last time you heard about someone reaching the goal of becoming a millionaire? Do you even think it's possible?

I certainly do.

Because over in the Bogleheads forum, which is frequented by average, everyday investors, a member recently shared how he reached the major milestone they call the "Two Comma Club."

This club is for people who have achieved a net worth figure with at least two commas in it (in other words, $1,000,000 and up). (See also: The Worst Investments You Can Make)

Here are the seven key lessons I learned from studying that post and comments to it.

1. Develop the Habit of Saving

In his very first post, our new millionaire said he was always a saver.

Being diligent in saving is the most important step in building wealth. It's even more important than finding the right investment.

Without any savings, you'll have nothing to invest — even if you have the "perfect" investment. But when you contribute to your investment accounts regularly, you harness the power of compound interest to boost your net worth over the long haul.

Here's another way to get serious about saving — when contribution limits for your retirement accounts increase, do what you can to max them out. Our millionaire used the extra money he got from pay raises and from paying off debts to do this.

2. Have a Purpose

Money is ultimately just a tool that'll help you achieve your other goals. So what are your life goals?

One commenter mentioned that after he reached $2 million net worth, he quit his executive position that kept him away from his family. Now, he can spend much more time with them.

Do you want to leave a stressful, unfulfilling job so that you'll have more time with your loved ones? Or do you want the ability to donate large sums of money to support a cause that's close to your heart?

Having a purpose in mind will keep you motivated to continue working hard when times get tough, and doing whatever it takes to reach your goal.

3. Learn and Get Help

Our millionaire said he didn't always know what he was doing. But he learned by reading good books and listening to knowledgeable people.

By doing this, he slowly got his financial act together. This shows that if you start early enough, mistakes aren’t fatal — as long as you learn from them and correct them.

So what's important to know when it comes to long-term investing? One major factor that influences how your investments will perform is your asset allocation. In other words, how do you divide your money between the two major types of investments — stocks and bonds?

If you'd like to learn the asset allocation that I follow, how this allocation has performed in the past, as well as how it's expected to perform in the future, check out the Core Four Portfolio.

4. Stay the Course

"Stay the course," was mentioned several times throughout the thread. All this means is to simply create an investment plan (such as the one modeled after the Core Four Portfolio), and then stick to it. Don't waver from your asset allocation when the market is going through a down period.

It's doesn't really matter how your investments perform in a year or two. Instead, it's more important that you stay invested over a decade or two. One commenter mentioned that it took 26 years of systematic investing in order to make it to the distinguished Two Comma Club.

5. Make Sacrifices

If something's really important to us, we'll do whatever it takes to make it happen. A commenter mentioned striving towards the Two Comma Club every single day.

Our millionaire made sacrifices by committing his future pay raises to paying off his mortgage early. That gave him the extra money to max out his retirement accounts and speed up his journey to financial freedom.

6. Surround Yourself With Like-Minded People

Birds of a feather flock together. By reading this millionaire's post, another commenter received encouragement and realized that the goal of becoming a millionaire was possible for him, too. Join an online forum such as Bogleheads for the motivation or form an investment club.

7. Once You Get There, Stay There

A commenter noted that the first part of your investment life is all about accumulating wealth. Once you've reached your goal, the second part of your life is all about not losing what you've worked so hard to gain.

How do you do this?

By continuing to do what you've been doing all along: Living below your means, paying yourself first, and managing your debt wisely.

For instance, since retiring, our millionaire is still in the habit of saving. He still develops savings goals for future spending. Yes, he's saved up for future vacations, car repairs, and property taxes among other expenses.

Which one of these seven investment lessons speaks the loudest to you?

Written by Darren Wu and published on Wise Bread. Read more articles from Wise Bread.

Best Money Tips: How to Safely Invest Your Money

Ashley Jacobs — Tue, 30 Apr 2013 09:48:33 +0000

Welcome to Wise Bread's Best Money Tips Roundup! Today we found some great articles on safely investing your money, ways to add value to your home before selling, and frugal bachelorette party destinations.

4 Ways Your IRA Beats Your Savings Account

Julie Rains — Fri, 26 Apr 2013 10:24:35 +0000

You may wonder why you should save money inside a retirement account.

The simple answer is that retirement assets are treated differently than regular assets. The federal government, many institutions, and probably even you tend to consider the money set aside to sustain yourself in your old age as sacrosanct. And there are real benefits to having this perception. (See also: 3 Reasons Not to Save for Your Child's College Fund)

Here are four big reasons to stash funds in a retirement account of your choice instead of a regular savings or investment account.

Retirement Assets Are Not Included in Calculations for College Aid

Even if you have hundreds of thousands of dollars combined in your 401(k) and IRA, your child could qualify for federal aid based on Free Application for Federal Student Aid (FAFSA) calculations. However, if this same amount of money is held in a regular account, then the likelihood of getting aid is greatly diminished.

Federal aid calculations are based on a variety of factors. Colleges and universities may have their own formulas, but these typically mirror federal guidelines. The Expected Family Contribution (EFC) considers regular assets but not retirement plans. Sure, a base level of assets is protected and a relatively small percentage is considered available to pay college expenses, but substantial holdings can increase this number to the point that your EFC easily exceeds the Cost of Attendance (COA).

Such a scenario may seem unlikely. If you have $500,000 or more saved or invested outside of retirement, then you might think that you would have a high income, a fully funded educational accounts; and a well-stocked retirement portfolio.

But you could have easily been a steady saver and accumulated significant wealth without the benefit of a high income, or you could have a high income for much of your working life but experience a career setback when your child enters college. So, putting money in an official retirement fund now can help your family qualify for federal aid in the future.

Tax Benefits Are Available With Retirement Accounts

Whether you have a traditional or Roth IRA account, you enjoy several tax benefits over a regular savings or investment account:

Reduction in the present-year tax liability for contributions made to a traditional IRA or 401(k) plan
Exemption of income taxes for qualified distributions from Roth accounts
Freedom from taxes on capital gains, interest, dividends, and other earnings while funds are held within the retirement account

Note that you’ll pay taxes on distributions from traditional accounts (that is, taxes are deferred until retirement rather than eliminated). However, no taxes on earnings are owed on Roth accounts prior to and during retirement.

Embedded in the benefit associated with deferring or avoiding capital gains taxes is the bonus of being able to diversify and rebalance your portfolio without tax consequences.

For example, if you have a large amount of your employer’s stock in your 401(k) plan or a concentrated position of one company in your IRA, you can sell these holdings to fund the purchase of index fund shares (or other investments that would diversify your portfolio) without having to pay capital gains tax. All of the proceeds can be plowed back into your retirement fund. However, if you sold a similar amount in a regular account, you would lose a percentage of your earnings to taxes (unless you qualified for 0% capital gains tax) and have less to reinvest.

Retirement Accounts Enjoy More Protection

Retirement funds are safer than non-retirement assets if you ever have to declare bankruptcy or shield yourself from a creditor’s claims.

Hopefully, you will never have to face these situations. But if such problems arise, money held in most employer-sponsored plans is protected from creditors in bankruptcy under federal law (with notable exceptions of the IRS and former spouses). Money in an IRA is also exempted to an extent (up to $1 million plus cost-of-living adjustments).

For non-bankruptcy situations, employer-sponsored plans compliant with the Employee Retirement Income Security Act (ERISA ), such as 401(k) plans, provide the best protection. IRAs may or may not be sheltered from claims based on state laws.

As an added precaution, no matter where your money resides, consider increasing liability coverage by getting an umbrella policy and boosting coverage associated with homeowners’ and auto insurance policies. These steps may help you pay claims in the event of a lawsuit without tapping retirement or non-retirement funds.

Retirement Funds Are Off Limits for Regular Expenses

You might think that if you mentally designate certain funds for retirement, then you won’t ever spend these dollars except in an extreme emergency.

But in the decades between setting aside money in your 20s and 30s and full retirement in your 60s and 70s, there are likely to be many opportunities to spend money earmarked for retirement but held in a regular account. These might include anticipated events such as your children’s college education or wedding; unexpected setbacks from medical expenses or long periods of unemployment; or hoped-for opportunities such as a backpacking trip out west, an extended overseas visit, or a bargain-priced vacation house.

Even money put in retirement plans isn't entirely safe. Certainly, many people withdraw funds for hardships, such as the down payment on a purchase of a home or those medical bills I mentioned earlier. And a recent study indicated that about 25% of employees are tapping 401(k)s for regular expenses.

Generally, though, money placed in a retirement account should stay there because you consider those dollars off limits. Tax penalties associated with taking retirement distributions early are often so high that forgoing opportunities, delaying spending, and finding alternative funds are often simpler and preferred solutions.

The main point of contributing to a 401(k), IRA, or similar plan is to accumulate assets that generate a stream of passive income, which helps you pay expenses when you are no longer working. You can build wealth in a manner that creates this income without opening an IRA or transferring money from your paycheck to an employer-sponsored retirement plan. But even beyond the basic tax advantages, there are tangible and intrinsic benefits to putting and keeping money in a retirement account instead of a regular one.

Where is your money? Have you thought about putting more in a retirement account?

Written by Julie Rains and published on Wise Bread. Read more articles from Wise Bread.

Why Canada’s TFSA Is Totally Awesome

Tara Struyk — Thu, 25 Apr 2013 10:24:33 +0000

In a recent article, I compared the Canadian and American retirement systems, and while I tried to include as much as I could, a lot of people jumped on my omission of the Tax Free Savings Account (TFSA). I left it out because, strictly speaking, a TFSA is not a retirement savings vehicle. But I should’ve included it anyway for one simple reason — TFSAs are totally awesome, especially for investors. That’s because if you put your investment in one of these, you don’t have to pay capital gains tax. For regular people, that’s as close as you can get to the benefits of an account in some tropical, offshore banking center (which, let’s face it, probably wouldn’t be interested in a $3,000 deposit anyway).

According to a poll released by the Bank of Montreal in November, about 38% of Canadians have a TFSA account. If you aren’t in that group, you’re missing out. Here I’ll go over this relative newcomer to Canadian financial (and yes, retirement) planning.

TFSA 101

First things first — the TFSA is poorly named and, as a result, many people assume that it’s a savings account. In fact, the TFSA isn’t an account at all; it’s more like a label that can be applied to all kinds of financial accounts, including regular savings accounts, stock trading accounts, mutual funds, bonds, and even certain types of small business shares. In other words, it isn’t just for saving. In fact, the TFSA’s tax-free capital gains mean you get the greatest advantage by using it to invest. Unlike virtually every other kind of account you could put your money into, if you use a TFSA, you won’t have to pay tax on any interest, dividends or capital gains you earn. Ever.

Of course, there are some limits. When the TFSA was introduced in 2009, every Canadian over the age of 18 got $5,000 of contribution room. Like a Registered Retirement Savings Plan (RRSP), this contribution room continues to accumulate each year, and remains open whether you use it or not. So, if you’ve never contributed to a TFSA, you could deposit as much as $25,500 in 2013 (the contribution was increased to $5,500 this year). Plus, that contribution room never goes away, even when you spend the money, which you can do without penalty whenever you choose. You could sock some money away for your retirement or pull it out and spend it on a nice vacation. Your choice. And hey, if you do manage a solid capital gain during the year, it might just be a very affordable trip!

Tax-Deferred Versus Tax-Free

What many people don’t understand about TFSAs is the tax implications, which explains why, according to the BMO poll, many people don’t use them effectively. So here’s a rundown.

TFSAs are tax free. That means that if you contribute $5,500 this year, make a great stock pick, and end up with $10,000 in your account by the end of the year, you can avoid paying what would normally amount to $675 in capital gains tax (assuming a 30% income tax rate). Pretty sweet, right?

Now take the RRSP. If you contribute $5,500 to this type of account instead, you can deduct that $5,500 from your taxable income, which could mean a tax refund. So, essentially, the money you contribute to an RRSP has not been taxed. However, if your contribution grows to $10,000, you will pay income tax on that amount when you withdraw it (which hopefully happens when you’re retired). The logic behind deferring your taxes until retirement is that many people have less income during retirement, and therefore a lower tax rate.

Why the TFSA Is Totally Awesome

What really sets the TFSA apart is that it’s flexible. You can use it to save money for short-term goals, or to save for longer term dreams like a new home or even retirement, and you withdraw that money whenever you want. Plus, if you’re already maxing out your RRSP, a TFSA gives a little extra incentive to save more. For those with lower incomes who might not benefit from an RRSP’s tax deduction, it also provides another option.

Whether you’re making big bucks trading stocks and other investments or just racking up a little interest, a TFSA means you won’t have to pay taxes on those gains. In other words, a Tax Free Savings Account is about as close as you can get to a free lunch in the investing world. And what budget-savvy person ever turns down one of those?

This post was made possible by support from Standard Life, a leading provider of Canadian pension plans

Written by Tara Struyk and published on Wise Bread. Read more articles from Wise Bread.

6 Valid Reasons Not to Contribute to Your 401(k)

Julie Rains — Mon, 25 Mar 2013 09:48:38 +0000

You’ve heard that you should contribute to your company’s 401(k), almost always. Don't feel bad or question your financial judgment if you've decided to invest elsewhere. There are valid reasons to be an exception to this general rule. (See also: Is It Time to Starve Your 401(k)?)

1. Your Company Doesn’t Match Your Contributions

If your company doesn't match your contributions, then 401(k) participation is not especially attractive. When I worked for large corporations, I contributed to my retirement through 401(k) plans but never received an employer match. Although I enjoyed the automatic savings feature and reduced tax liability, I didn't get bonus money from my employers for saving.

Many advisors emphasize that you should set aside enough money to get the employer match. However, they often don’t mention that nearly half of employers don't provide this incentive.

Not getting a match shouldn't automatically dissuade you from contributing to your 401(k) plan at work. But this scenario should encourage you to consider other retirement account options.

2. You Plan to Leave the Company After a Couple of Years

Even if you are eligible for the company match, you may not receive this money when you quit your job. Generally, you need to work for your employer for a while to become fully vested and receive the matching dollars. A notable exception is the Safe Harbor 401(k) plan, which requires all employer contributions to be fully available to employees regardless of tenure.

Vesting schedules vary. Typically, you’ll need to be an employee or participate in the plan for several years. Often, you’ll get ownership of the match over time or at the end of a specified term (for example, you'll gain access to 20% every year for five years or get nothing for the first six years and then become 100% vested in year seven). Look at your 401(k) plan documents to determine when ownership of the employer match is transferred to you. Note that you always have ownership of your contributions.

Just as not getting a match doesn't negate the value of the 401(k), having to wait to become fully vested doesn't mean that you should definitely skip enrollment. However, it's helpful to consider your career plans and vesting schedules when making this decision.

3. You Want to Pay Off High Interest Debt

If you are carrying thousands of dollars in high interest debt, then you may want to focus on paying off loan balances at home instead of contributing to your 401(k) plan at work. Diverting money from retirement funding to debt payoff for a couple of years could make sense, especially if you are burdened financially and psychologically by credit card debt.

Company matching percentages, loan interest rates, loan balances, tax brackets, and investment returns play a role in calculating what is best for your situation. For a discussion of this topic, see Philip’s post on funding your 401(k) when you’re in debt.

Your goal should be to establish a habit of financial discipline, whether contributing to your 401(k) plan or paying off loans. Consider your financial priorities and inclinations; if you opt to pay off credit card balances, commit to spending less than you earn and building your retirement account as soon as your high-interest balance hits zero.

4. Your Employer Offers a Lousy 401(K) Plan

You may choose to invest on your own rather than put money in your employer's 401(k) if the plan has undesirable investment options and unreasonably high costs.

Look at the disclosures to gain insight into the worthiness of your company's 401(k) plan. According to the Society for Human Resource Management (SHRM), you should receive information on mutual fund performance compared to benchmarks as well as administrative, investment, and service expenses. See this infographic for an explanation of the differences in these types of fees. In addition, check BrightScope ratings to see how your employer’s plan compares with its peers.

Certified financial planner Roger Wohlner gives tips on the types of mutual funds that may indicate a lousy plan. For example, if your choices are limited to proprietary funds associated with the plan provider, one fund family (only T. Rowe Price funds in all asset classes, for example), or expensive share classes, then your plan may not be designed for the optimal benefit of employees.

Examine your 401(k) to figure out if your employer is offering an excellent, average, or subpar plan. Based on your discovery, you may decide to open and fund an IRA to build wealth instead of participating in your company's plan.

5. You Need Cash to Make a Down Payment on a House

While you can tap your retirement funds by taking a hardship distribution or borrowing on your balance, there is a simpler way to get money for the purchase of a primary (or principal) residence. Forgo 401(k) plan contributions for the moment, save in a regular account, and earmark funds for this purpose.

If you withdraw money from a traditional 401(k) account prior to retirement age, you will owe taxes on the distribution amount plus a 10% penalty in most cases. Also, you won’t be able to contribute to the plan for several months. Alternatively, you could borrow from the account; however, a loan detracts from your long term ability to save plus requires you to pay outstanding balances immediately if you leave your employer.

So, rather than funding your plan at work, consider setting aside a certain amount to accumulate a down payment. Then, after you purchase the house, you can start (or restart) contributing to your 401(k).

6. You Want to Fund a Roth IRA

If you have a healthy balance in traditional retirement accounts (and your employer doesn't offer the Roth designated account within its 401(k) plan), you may want to skip contributions at work and put money into a Roth IRA.

While traditional retirement plans give you a tax break now, the Roth allows you to withdraw funds tax-free when you reach 59½ (or earlier in certain circumstances). Also, unlike regular IRAs and traditional 401(k)s, you can take money out of the Roth at your leisure rather than according to a certain schedule in retirement.

To be clear, you don’t have to choose between a Roth IRA and your employer’s 401(k) plan (however, there are income-based limits on Roth contributions). But if you meet income standards and have limited amounts of money to save for retirement, then you may want to stop participating in the 401(k) plan in order to fund the Roth IRA.

Certainly, there are many reasons you should participate in a 401(k) plan, including the ease of setting aside money for your retirement on a regular and automatic basis plus the ability to save a large amount each year within this retirement account (more than $17,000 per year in a 401(k) plan versus just $5,500 in an IRA). But you shouldn't feel uneasy if you decide to take a different route, particularly for a year or two, depending on your circumstances.

Have you decided not to participate in your company's 401(k) plan? Have you still been able to save for retirement?

Written by Julie Rains and published on Wise Bread. Read more articles from Wise Bread.

How to Set Up an IRA to Build Wealth

Darren Wu — Tue, 19 Mar 2013 10:00:42 +0000

Here's some food for thought — if you save just under $11 a day in an investment that grows 8% each year, and in 40 years you'll have $1 million.

What would you do with a million dollars? Would you travel the world, visiting a new country every month? Support a cause that's dear to your heart?

How would you feel? More secure, knowing that you accomplished the goal of being able take care of most of your expenses?

To put this in perspective, you'll put in less than $150,000 of your own money, yet you'll end up with over six times that amount. That demonstrates the time value of money and the incredible power of compound interest.

And it gets even better. An IRA is a great place to do all your saving, because you'll get some nice tax benefits — benefits that'll put even more money in your pocket.

Let's get started. Here's how to set up a wealth building IRA in four simple steps. (See also: Choosing a Retirement Account: What's Available, and What's Best for You?)

Step 1: Traditional or Roth?

There are two types of IRAs, and the first step you need to take is to decide which one of the two you want to open — a Traditional or Roth IRA.

What's the difference between the two?

With a Traditional IRA, your withdrawals at retirement are taxed, but your yearly contributions are tax deductible. This means that if you contribute $5,500 every year and you're in the 25% tax bracket, you'll also save $1,375 in taxes every year.

With a Roth IRA, you contribute with after-tax money, but your withdrawals at retirement are tax free. This means that if you retire with $1 million, you won't have to pay taxes on a single penny of that $1 million.

Which one should you choose?

If you're just starting out in your career and have a relatively low salary, it may make more sense to pay taxes now while you're still in a low tax bracket. In this case, choose the Roth IRA.

But if you're making the big bucks and you're at the height of your earnings potential, you'll probably be in a lower tax bracket in retirement. In this case, choose the Traditional IRA.

There may be other factors that come into play when deciding between the two, but the guidelines above provide a good starting point. If you want help making a more informed decision, check out the IRS's guide to IRAs.

Step 2: Which Company?

Once you decide which type of IRA is best for you, the next step is to decide which company you want to invest with. The main things you want to look for in a company are:

The availability of good mutual funds
Low fees
Low minimum opening requirements

Several reputable companies meet these three criteria. Two of the well-known ones are Vanguard and Fidelity. As such, they're the ones I'll be referring to in more detail below.

Step 3: Which Fund?

After you decide which company you want to invest with, the next step is to choose your investment. There are several ways to invest, and several types of investments to consider.

But I'll share with you the two methods that experts in the personal finance community suggest. These methods will save you money and build more wealth.

Hands-Free Funds

The first method is for those of you who want to stay hands-off, yet still earn a good return on your money. If you don't want to actively monitor your investments, then target date retirement funds are for you. Just pick the fund with the year closest to the time you want to retire, and you're good to go. Set it, and forget it.

Fidelity Freedom Funds have a $2,500 minimum in order to open an account. They come with expense ratios between 0.44% and 0.76%.
Vanguard Target Retirement Funds have a lower minimum, requiring just $1,000 in order to open an account. They're also cheaper to own, with expense ratios just between 0.16 % and 0.18%.

Hands-on Funds

The second method is for those of you who want to be more hands-on and pay less in fees. If you want to reduce your costs of investing, consider building a portfolio that you manage yourself.

Most Fidelity index funds have a $2,500 minimum, and expense ratios between 0.10% and 0.34%.
Most Vanguard index funds have a $3,000 minimum, and expense ratios between 0.18% and 0.24%. By buying a few different funds at different dollar amounts, you'll end up paying less in fees.

If you'd like to see an example of how I do it, check out the Core Four Portfolio.

Step 4: Contribute Regularly

After you've chosen your investment, the last — and most important — step is to contribute to your IRA on a consistent basis.

Remember that million dollar example at the beginning of this post? For the time value of money and the magic of compounding to work for you, you need to invest regularly. Fortunately, this is simple to do.

Just like you can invest in your 401k automatically every two weeks through direct deposit from your paycheck, you can also automatically invest in your IRA in the same way. By setting up automatic transfers from your checking account to your IRA, you'll build wealth with much less effort.

Remember, just $11 a day can deliver a million dollars your way.

When will you set up an IRA and begin building wealth?

Written by Darren Wu and published on Wise Bread. Read more articles from Wise Bread.

6 Ways to Get Paid for Saving Money

Julie Rains — Wed, 06 Mar 2013 11:36:33 +0000

You can make money by saving money, apart from interest, dividends, and investment earnings. These methods deliver bonuses in ways you may not have recognized as getting paid to save. (See also: The 5 Best Online Savings Accounts)

1. Claim the Saver's Credit

This money comes from the federal government via the IRS. Through the Retirement Savings Contributions Credit (aka Saver's Credit), you can get up to $1,000 (or $2,000 if married filing jointly) if you contribute to a qualified retirement account and meet certain requirements, which most notably include income limits.

You can't make more than $28,750 in modified adjusted gross income ($43,125 if head of household or $57,500 if married filing jointly) to be eligible. At those income levels, you may not have a lot of extra cash to sock away for retirement, but if you do save, you'll get a nice bonus. Use Form 8880 to calculate and claim your credit.

2. Win Prizes and Rewards for Saving Money

You can earn rewards and may be able to win prizes by tracking your savings with a couple of online services.

SaveUp helps you to monitor savings and debt payoff, and gives you the opportunity to play for prizes that range from a $100 gift card to a $2 million jackpot. The site also dispenses rewards in the form of promotional offers.
SmartyPig gives you a place to save money for specific purposes such as a summer trip to the beach or new flooring for your house. When you have accumulated the dollars, you can redeem your savings by 1) transferring money to your checking account, 2) loading money to a prepaid debit card, or 3) receiving a gift card from certain retailers. While option #1 doesn't give you extra cash, you'll get 1% more if you take your savings on the debit card and a bonus of up to 11% if you choose a gift card.

3. Earn Bonuses for Setting Aside Money in Savings Accounts

Many banks and credit unions have cash incentives for customers who commit to saving. For example, BBVA Compass matches a percentage of transfers from a checking account to a savings account; you can earn up to $250 per year through the Build My Savings program. Bank of America also contributes up to $250 through its Keep the Change program.

And, I learned via Money Crashers that Citizens Bank has a CollegeSaver savings account that gives a one-time $1,000 bonus when your child reaches 18 if you make minimum monthly deposits.

4. Get Cash for Opening and Funding an Investment Account

Brokerage firms offer incentives for opening and funding an investment account. To get rewards, you typically have to make a hefty deposit. For example, to earn $200, you'll need to put $50,000 in a new account with Charles Schwab (but you can earn $100 on a deposit of just $10,000 if you are an AARP member).

However, your bank, credit union, or other financial institution may offer more accessible deals. For example, ShareBuilder is offering a $50 bonus to open and fund an IRA with $5,000.

5. Snag Your Company's Match

You can make extra money courtesy of your employer if you contribute to a qualified retirement plan and your employer matches contributions. Review plan documents to verify that a match is available. Set aside the percentage of your pay that harvests the maximum payout from your employer.

6. Take Tax Deductions

The federal government and most state governments give you a bonus (in the form or lower taxes) for your contributions to traditional retirement accounts (such as traditional 401ks or IRAs) and Health Savings Accounts (HSAs).

There are restrictions for tax deductions, generally based on earnings and the amount of deductible for the high-deductible health plan linked to the HSA. But if you qualify for tax deductions and put money in these accounts, you can lower your tax liability and increase your cash inflow, either from a larger refund or smaller tax payment.

Even though interest rates are low and rewards for saving are often small (even in a high-yield CD) or uncertain in investment accounts, there are ways to get cash bonuses that boost your bottom line.

How have you made money by saving money?

Written by Julie Rains and published on Wise Bread. Read more articles from Wise Bread.

The False Allure of Compound Interest

Philip Brewer — Wed, 06 Mar 2013 10:48:34 +0000

You've seen compound interest stories. Just save $10 or $50 a week or a month and in 25 or 35 years you'll have a fortune! It's not so simple. (See also: Non-Financial Investments)

The compound interest story isn't wrong, exactly; it's simply misleading.

It's misleading for two big reasons. First, because things change. Second, because the huge returns from compound interest are back-loaded — they only come at the very end.

Let's start with a simple example, so we have something specific to talk about. According to my financial calculator, if you invest $218 per month at an 8% return over the course of a 35-year career, you'll end up with $500,000. Depending on your lifestyle that might or might not be enough to retire on, but it would at least be a tidy contribution to any retirement.

It's a perfectly reasonable calculation — I'm sure lots of people made that exact calculation many times during the 1990s, when people actually were achieving returns like that. I'm sure I made that exact calculation myself.

So what's wrong with it?

Things Change

First of all, you've got almost no chance of getting an 8% return for 35 years. It's possible to get an 8% return — during the 1980s and 1990s it was easy to get an 8% return. But 35 years is a long time. Things change. Over that much time you can expect interest rates to go up and down, you can expect the stock market to go up and down, you can expect inflation to go up and down, you can expect taxes to go up and down.

If you were really lucky, and started your investment program in 1981, you'll have done very well. Interest rates started out high and then declined gradually for the next 30 years. If you just bought 30 year bonds every time you had enough money to do so, you made huge gains. Except, of course, no one who started investing then would have done so. In 1981 everyone knew that bonds were trash, because we were just coming off a decade of inflation rates so high that bond investments lost huge amounts of money in real terms.

If you'd invested in stocks you'd have done even better, at least until 2001 or so. The stock market soared! In the dotcom boom, any reasonably diversified stock market investment made 20% returns for three years in a row! Except, of course, after the dotcom crash the stock market went sideways for a decade, and then in the panic of 2008 lost 40% of its value in one year.

If you were just starting to invest in 1981, you'd probably have just put your money in a money fund. After all, they were paying 14%! And they provided great inflation protection, because rates went up when inflation went up! Except, of course, when inflation went down the rates went down. Nowadays you're lucky if you can get 0.8%.

Another place you could have put your money in 1981 was gold. Gold looked pretty good right then — over the previous decade or two it had run up from $35/oz to something like $800/oz. Of course, then it proceeded to collapse and spend most of the next couple of decades at around $300/oz. Now it's back up to double its 1981 peak. For those of you keeping track at home, doubling your money in 33 years amounts to a return of just over 2%.

Finally, be aware that changes in the return on capital are really the most benign kinds of changes. Over that period of time, you also have to expect major changes in the return of capital. You have to expect that some companies will go bankrupt, leaving their stockholders with returns of zero. You have to expect that some countries will "restructure" their debt, leaving their bondholders with pennies on the dollar. You have to expect that some currencies will collapse, leaving their holders with nicely printed pieces of paper.

So that's the first problem. The period of time it takes for compound interest to start racking up those outsized returns is so long that ordinary changes are very likely to invalidate your plan.

Returns Are Back-Loaded

The other problem is that the huge returns from compound interest only really accrue at the very end.

If you stick with the program for the full 35 years, you get your half million. But suppose things go awry. Suppose you have to quit after just 15 years. That's still a chunk of time, right? I mean, it's almost halfway, right?

It may be almost halfway, but that does not mean you get almost half the money. In fact, after 15 years all you're going to have is $75,000. That's a pretty small fraction of your half million.

In fact, even if you stick it out for 25 years, you're only going to have $207,000, well under half your goal, even though you've stuck to your savings plan for more than two-thirds of the total time.

This back loading doesn't just make your result terribly sensitive to ending your contributions early, it also makes your result terribly sensitive to the terminal interest rate.

Suppose you stick out the whole 35 years, making every payment exactly as planned. Suppose further that you manage to achieve your planned 8% return for the first 30 years, but your average return over the last five years is only 1%. How much difference does that make? It takes your total return down from half a million down to just $355,000.

So that's the second problem. It turns out that it's not good enough to get a good average return over the whole period; unless you get a good return over the last few years, your compound return ends up being crappy.

None of this is to say that compound interest can't work for you — it can. Save and invest — and keep an eye on your investments, on the markets, and on the investment climate generally — and you can probably expect to make good returns over the long-term. Just be very careful about buying into the story of compound returns too literally.

Written by Philip Brewer and published on Wise Bread. Read more articles from Wise Bread.

Women: How and Why to Take Charge of Your Finances

Meg Favreau — Fri, 22 Feb 2013 11:30:00 +0000

Ladies, I’m going to be blunt — the statistics about how we handle our finances are depressing.

A USA Today article from August 2012 notes that, “Many studies in the last decade have shown that women consistently feel less confident than men in their understanding of financial products, their ability to make financial decisions and their perception of their current economic standing.”

I’m not trying to peddle some “This is how women just are!” bunk here. I firmly believe that men and women are equal, and women have the tools and power to be fully in control of our finances. But the really depressing thing is that research shows that, all too often, we aren’t.

There isn’t just one reason why women aren’t as financially in-charge as they should or could be, but several experts point to women’s traditional role, where the husband was typically the breadwinner and in charge of the family finances. Even now, women typically gravitate more towards penny-pinching than investment. Again, it makes sense if you’re looking at traditional roles — housewives were tasked with stretching grocery dollars, keeping clothing in good repair, and so on. But when I read that, it shocked me to realize how much that resonated with my own life. Even as a financially savvy and independent woman, I have to admit that I know more about stretching the money and things I have than making investments.

Why should we be better with our finances? Well, partially for the same reasons that any human should be financially savvy — to be confident, secure, and independent. But, unfortunately, women also have some additional concerns — for example, we generally live longer than men and make less, which leaves us with less money set aside for retirement. And living longer also means that we’ll likely need to make decisions about financial products like long-term care insurance — for ourselves and for others. According to an article from the Women’s Institute for Financial Education, “Because women live longer than men, they require lengthier care as they age, and because women often assume responsibility for their family’s health and welfare, the task of caring for elderly parents, an ill spouse, or disabled brothers and sisters usually falls to us.”

Whether you’re single or with a partner, better understanding your financial picture can save and make you money, put you in a better situation for retirement, and help you protect yourself and your family in case of an unexpected emergency. (See also: Financial Educational Resources for Women)

If you feel like you have gaps in your financial knowledge, here’s what to do.

Make a Budget

If you don’t already use a budget, make one now. A budget is one of the most basic and powerful financial tools you can have — not only does it help keep your spending down, but it also helps you understand where your money is currently going, and where it could go. Having a budget is sort of like that old adage about how you need to love yourself before you can love someone else — you need to understand where your money is going on a day-to-day basis before you think about investing it elsewhere.

Forget What You’re “Not Good” At

Before you start diving into financial education, you need to internalize this: You can do it. And you can be great at it.

One reoccurring theme in the research about women and money is the sense that many women think they just aren’t good with money, numbers, or math — especially on the investment side. But if you’re ignoring your finances just because you think you aren’t good at it, you’re both hurting your financial health and selling yourself short. At any age, humans have an incredible ability to grow, adapt, and learn — plus doing things you’re bad at has benefits beyond just learning new information, such as actually making you smarter.

It’s also interesting to note that even though studies show that women often know less about investing than men, research also suggests that when women do invest, they make better investment decisions, partially because they’re more in touch with their emotions and less likely to take huge risks.

Get Educated

Now that you have a picture of your day-to-day finances and a positive attitude, it’s time to learn.

I suggest making a list of all of your financial accounts and obligations — loans, retirement accounts, bank accounts, and so on, as well as ones that you could have, but don’t yet (say, for example, if you’re interested in opening a money market account, but haven’t yet). Put a star next to any you feel like you don’t fully understand, and start researching.

Researching online is great, but one issue that the USA Today article points out is that the financial services industry “still overwhelmingly caters to men in the way it presents and discusses information and products,” and that women tend to shy away from jargon and prefer a personal approach. If you feel like you don’t understand something you’re reading, don’t be afraid to seek help — whether it’s from your partner, a friend, or a certified financial planner.

Here are some resources to get you started:

Make Sure Your Financial Education Is Comprehensive

I mentioned before how much it resonated with me to see that women are often dollar-stretchers, but not investors. Just because you practice good financial habits in one area doesn’t mean that your knowledge is comprehensive. Examine your entire financial life, and make sure you aren’t ignoring any areas. Consider learning more about:

Retirement accounts (401(k)s, IRAs, Roth IRAs, pensions, etc.)
Investments (index funds, annuities, bonds, etc)
Insurance (health, life, long-term care, homeowners, car, etc.)
Loans (student loans, mortgage, credit cards, etc.)
Frugal living (making smart purchases, examining needs vs wants, reusing and making do instead of buying new)

Focus on Goals

In this piece on Time’s website (originally published in Real Simple), writer Geraldine Sealey notes that women work better with specific goals than with numbers. Her suggestion? Instead of simply trying to amass more wealth, “Make your financial goals as detailed as possible (included an estimated cost) to increase the likelihood that you’ll follow through with what’s necessary to achieve them.” Whether your goal is to buy a house, have a six-month emergency fund, or be able to travel when you retire, making specific plans can help you achieve the goal.

Do It

Just do it. Sign up for a retirement account if you haven’t already. If your partner is usually in charge of your family finances, ask to share responsibility or take it over. Anyone who’s tried to learn a foreign language in school and then traveled to the country where people speak that language will tell you — you learn better and faster when you have to.

Do you feel like you’re financially savvy? What helped get you there, or what are your goals?

This article was made possible by the support and inspiration from Genworth Financial, a S&P 500 insurance company with more than $100 billion in assets. Check out Genworth's website for more financial education resources for women.

Written by Meg Favreau and published on Wise Bread. Read more articles from Wise Bread.

Intro to 5 Super Safe Investments

Miranda Marquit — Fri, 01 Feb 2013 11:36:35 +0000

We’re all looking for ways to maximize our money by earning a little interest. However, when we invest, we take on a certain amount of risk. The more risk we take on, the higher the potential return.

If you want some returns, but aren’t interested in taking on a great deal of risk, there are some investments that are considered a little safer than others. Investing in these products can provide you with a return, but it won’t likely be a huge return. (See also: Investments Worth Making With $50 or Less)

What Makes Investments “Safe”?

While there is no way to completely avoid risk, there are some investments that are considered “safer” than others. These investments are considered safe because they might be guaranteed by insurance or provide you with a constant rate of return. Others are considered safe because of who backs them.

Realize that there is always a trade-off for this safety. In return for lower risk, you have to accept that you won’t see as large a return. Indeed, in return for keeping your principal safe, you might actually end up returns so low that your biggest risk is inflation.

Here are five investments that are generally considered “safe."

1. Savings Account

Looking for a high-yield savings account these days seems like a fruitless endeavor. You are lucky to earn a 1% APY. However, these are often considered among the safest places to park your cash. Your principal is protected, up to $250,000 per bank, by FDIC insurance. This means that if the bank fails, you will get your money back.

Many banks also carry other types of insurance that can protect your principal in the event of theft or other problems. Make sure you understand what’s covered, since there are some circumstances in which you might not get your principal back.

It’s fairly easy to open a savings account. There are several online savings accounts that offer competitive yields (for the current environment). All you need is basic personal information and an initial deposit, and you can keep your money in a highly liquid account that earns a little something more than your piggy bank.

2. Certificate of Deposit

In most cases, you can find better yields if you decide to go with a CD rather than a savings account. A CD requires that you commit to keeping your money in the account for a specific time period, often ranging from three months to five years (although there are CDs with shorter and longer terms).

In exchange for your willingness to lock up your money for a specific period of time, you receive a higher yield. Invest in a CD at a financial institution that is properly insured. That means a bank with FDIC insurance or a credit union with NCUA insurance. Your principal will be protected from bank failure.

As with the savings account, your main risk with a CD comes from inflation. Even though you can get a higher rate by investing a larger sum of money for a longer period of time, you might still not be able to beat inflation with your return.

You can open a CD fairly easily with your personal information. There are numerous online financial institutions that offer CDs. You might be required to have a minimum deposit for some CDs, especially if you want a better yield.

3. Money Market

Money market accounts are special checking or savings accounts that earn a yield related to the current rates offered in the “money markets,” where short term CDs, Treasuries, bonds, and other very safe investments are traded. If you invest in a money market checking or savings account, your principal is usually protected if you go through a properly insured financial institution. As with checking accounts and CDs, your primary risk will be inflation, which can erode the “real” value of your principal over time.

Opening one of these accounts is fairly straightforward. You will probably (but not always) need a minimum deposit, and be required to maintain a minimum balance, in order to receive the best yield on your money.

Understand that a money market bank account is different from a money market mutual fund. A money market mutual fund is generally considered low-risk, since it invests in cash and “cash-like” products. However, a money market mutual fund isn’t FDIC or NCUA insured, so you can lose your principal. It hasn’t happened often, but there have been instances of money market funds reporting losses. You can find money market mutual funds through most brokers.

4. Treasury Securities

Treasuries are considered among the safest investments in the world because they are backed by the U.S. government — which is in turn supported by what many consider the most stable taxpayer base in the world.

Treasuries are bonds and are used to fund government operations. You can choose from a number of dollar amounts and maturities. The government uses the money and pays you interest. After the maturity period passes, you receive your principal back; you should receive interest payments during the entire period.

It’s important to note that, even though many consider Treasuries a “sure thing,” there is still the possibility of a default. You could, in theory, lose your principal. Also, because rates are low right now, you could face inflation risk on some Treasury products. If you want to reduce your exposure to inflation and protect your principal, you can invest in TIPS or I-bonds, which adjust for inflation.

The best way to invest in Treasury securities is by setting up an account through Treasury Direct. It’s fairly easy to open an account with your personal information, and then begin investing in the securities of your choice. Note that Treasury Direct handles all transactions electronically now; you won’t be issued paper savings bonds.

5. Annuities

Annuities are a bit tricky. They are considered safe because your principal is largely protected (depending on the type of annuity you choose). Annuities are also considered attractive because they offer guaranteed returns. However, annuities can also be complex and riddled with high fees.

The theory behind an annuity is fairly straightforward. You pay large sum of money, and the insurance company guarantees that you will receive a regular income. The income you receive depends on how much money you use to purchase the annuity, and how long you expect to receive payouts.

There are many annuity products. Some of them guarantee your principal, while others can actually result in a loss of principal if something goes wrong. You have to be careful of beneficiary rules, as well as high fees. Do not invest in an annuity until you have had a trusted financial professional, who has no interest benefit from selling you the annuity, review the terms.

Most insurance companies offer annuities. Research the rating of the insurance company, though, since you risk losing your principal if the company fails and isn’t backed up by some sort of guaranty fund.

Bottom Line

There are a number of investing options that can provide you with relatively safe returns. However, you still face risks, and it’s important to understand those before you proceed.

Written by Miranda Marquit and published on Wise Bread. Read more articles from Wise Bread.

A Guide to Online Brokers for Investing Newbies (and Beyond)

Julie Rains — Thu, 03 Jan 2013 11:36:31 +0000

Online brokers are known for cheap commissions on stock trades, along with low-cost account management services. These firms provide a place to start, grow, and maintain financial investments through regular brokerage accounts, retirement accounts, and more. Investment products available to fund these accounts may include stocks, ETFs (exchange-traded funds), and mutual funds.

Although online brokerage services were originally started as DIY alternatives to pricey traditional brokers (think Merrill Lynch in "Mad Men" days), they now offer a full range of services. Most have educational resources on investing along with tools for selecting and evaluating specific stocks. Many provide financial advisory and portfolio management services. (See also: 5 Killer Free Investment Tools)

Background

To understand and appreciate the services offered by online brokers, knowing the background of brokerage houses can be helpful.

In the 1980s and earlier, investors typically had few choices when purchasing publicly-traded stocks and mutual funds. They could:

Buy and sell stocks using a full-service brokerage firm, paying commissions that typically exceeded $100 per transaction
Invest in a specific company that offered a DRIP (dividend reinvestment plan) by purchasing shares on a monthly or quarterly basis
Purchase shares of mutual funds directly from the fund family, which involved paying sales and redemption charges on load funds while avoiding commissions on no-load funds

Trading fees at full-service firms were steep, as they covered sales commissions of stockbrokers. Ideally, the stockbroker recommended trades that were suitable for and benefited the growth of your investment portfolio based on proprietary market research of the brokerage firm.

But even if you didn’t need or want advice from the stockbroker, you still had to pay a sales commission. Discounted brokerage services were made possible when the SEC mandated negotiated rates in 1975, eliminating fixed commissions. In the 1990s, these discount brokers introduced web-based services so that customers could make online trades rather than giving orders to a phone representative.

Online brokers have continued to evolve. Product offerings now include options and foreign stocks. Just as significantly, many serve more than the DIY market through financial advisory and money management services.

Ways to Evaluate Brokers

There are many ways that you can evaluate and choose an online broker. The cost of a standard online stock trade, account minimums, and account maintenance fees are the features most often touted. (See downloadable spreadsheet: Basic Guide to Online Brokers, comparing various brokers.)

Those factors are relevant, but there are also additional elements to consider in selecting a broker (or brokers).

Stock and ETF Trading Costs

The most prominent measure of an online broker is the cost of an online stock and ETF trade. Typically, these are flat fees regardless of the number of shares bought or sold.

Note the standard fees for online trades (as of December 2012):

Charles Schwab: $8.95
E*Trade: $9.99
Fidelity: $7.95
Merrill Edge: $6.95
Scottrade: $7.00
TD Ameritrade: $9.99
TradeKing: $4.95
T. Rowe Price: $19.95
Vanguard: $20.00
WellsTrade: $8.95

Some brokers trade certain ETFs commission-free. On the other hand, fees for trading penny stocks (generally defined as equities with share values of $2 or less) may be higher and include charges related to the number of shares in the transaction.

Also, if you need to make the trade via an automated phone line or with the assistance of a broker, then you’ll typically pay either a higher flat fee or an added service charge. These fees may run up to $44.99, cheaper than traditional brokers but not nearly as inexpensive as standard online rates. However, you should be able to engage a phone rep in walking you through the mechanics of a trade that you initiate and complete online without an extra charge.

Account Minimums

If you are just getting started in investing, the minimum amount to open an account is of particular importance. This number often varies on the type of account. A regular brokerage account generally has a higher minimum than a retirement account, such as a traditional, Roth, or SEP-IRA.

Minimums to open a regular account are:

Charles Schwab: $1,000
E*Trade: $500
Fidelity: $2,500
Merrill Edge: $0
Scottrade: $500
TD Ameritrade: $0
TradeKing: $0
T. Rowe Price: $2,500
Vanguard: $3,000
WellsTrade: $1,000

When talking with broker representatives, I learned that account minimums can be flexible. For example, a phone rep at Schwab said that the account minimums on its website are "suggested" rather than required. Similarly, a Fidelity rep told me that there is no minimum to open a brokerage account, but mutual funds generally have $2,500 minimums. E*Trade accounts can be opened for $0 and then funded over a period of two months. Some minimums can be waived if you opt to make automated monthly contributions.

Account Fees

Many online brokers boast the absence of annual maintenance fees. And, thankfully, the majority of firms do not charge to hold your account.

Still, it’s a good idea to ask about fees. These could include account opening fees, account closing fees, or quirky fees such as TradeKing’s inactivity charge or low-balance fees charged by Fidelity and T. Rowe Price. Some fees can be waived by meeting certain conditions that could include choosing paperless delivery of monthly statements or maintaining a certain dollar value of assets.

Mutual Funds

Online brokers vary greatly in their scope of mutual fund offerings and associated fees.

However, nearly all distinguish between no-transaction-fee (NTF) mutual funds and transaction-fee mutual funds. Put simply, you pay no fee for an NTF purchase or redemption but pay a flat fee for buying or selling transaction-fee funds. (Note that an NTF fund may or may not be a no-load fund. For example, some brokers charge no commission for load funds, presumably earning a sales commission from the fund company rather than charging the individual investor. Some charge a commission for no-load funds.)

A few brokers have designed mutual fund networks or programs allowing commission-free purchases and redemptions. These programs may contain proprietary funds (created and sold by the brokerage firm) and/or selected mutual funds from outside fund families. For example, you can purchase Fidelity funds for free at Fidelity but pay a $75 commission for non-Fidelity funds. Similarly, an investment in one of the funds associated with the Schwab OneSource Program is free; purchases outside of this program are $76.

In addition to the commissions and fees charged by brokers, a mutual fund company may have fees distinct from the purchase or sales transaction; discussion of these fees can be found in the fund prospectus. Further, many brokers charge an early redemption fee for funds sold within a designated time frame after a purchase (generally 90 days or less).

Some investors favor online brokerage services with historical roots as mutual fund companies. For example, Mike Piper, a CPA who writes about low-maintenance investing at the Oblivious Investor, likes Vanguard and Fidelity because of the breadth of mutual fund offerings available commission-free, particularly for tax-advantaged accounts such as Traditional IRAs, Roth IRAs, and SEP-IRAs.

Customer Service

Customer service is delivered through toll-free phone calls, live chats, email, secure messaging systems requiring account log-in, and face-to-face consultations at branch offices. The responsiveness, availability, and expertise of service representatives will depend on your choice of online broker.

Even if you expect to handle transactions exclusively online, you may occasionally need help in these areas:

Responses to general inquiries about fees, opening an account, etc.
Assistance with account-specific concerns relating to trades, account balances, etc.
Financial advice pertinent to your goals and risk tolerance.

General guidance is typically free, but more expert direction can cost you.

Investing Resources

Most online brokers offer investor education for DIY investors that is particularly useful for newbies. Some provide more sophisticated tools and expanded services to advanced investors and those with large investment portfolios.

The types of resources:

Market news, insights, and commentary
Education on products and types of investment accounts
Investment planning tools
Trading and analysis tools (including real-time, streaming quotes)
Financial planning services
Portfolio management services

Certain services are ideal for those who enjoy the value-consciousness of an online brokerage firm but are willing to pay for expert financial advice. This group of investors can tap the knowledge of a financial advisor for specific concerns, locate and fund a pre-fab investment portfolio that matches their risk tolerance, or enlist the services of a money manager.

Deals

Most brokers have deals for new or active customers. These generally include:

Cash bonuses for opening an account or adding to its balance
Free trades for referring a friend or maintaining a high account balance

Note that qualifying amounts for bonuses can be very high though the average investor can typically qualify for free trades.

How to Choose an Online Broker

When reviewing the price structures and services of online brokers, notice the strengths that are most closely aligned with your needs. Start with identifying your needs now and those you anticipate having in the future. Ask yourself questions like these:

What type of account do I want to open?
What types of investments do I prefer?
How much do I have to invest now?
What is my level of comfort with independent investing?
Would I like to have assistance in managing my money?

Also, determine if you have special needs. Your responses will guide your decision as you choose an online broker.

For example, if you are most interested in investing in mutual funds, then a firm with a wide variety of no-transaction fee funds is ideal.

If you hope to grow your account balances to a level that will qualify you for specialized services, then the firms with full-service features at a relatively low cost may be perfect for you.

If you want to invest in IPOs, Kiplinger mentions that Schwab, Fidelity, and TD Ameritrade can provide client access to initial public offerings.

If you want to open a Roth IRA for your child, Doug Nordman, a military veteran who writes about early retirement and financial independence, tells me that certain brokers will allow minors to have a Roth IRA while others don't provide such services.

If you have a variety of needs, you may want to open more than one account. Using this approach, you'll forgo some benefits associated with high-dollar balances but may be able to save on fees for certain types of investments and transactions. Whatever you decide, don't be afraid to ask for specialized services at no cost or a reduced fee.

What fees, account features, and services do you consider most important when evaluating an online broker?

Written by Julie Rains and published on Wise Bread. Read more articles from Wise Bread.

Money Resolutions: 6 Ways to Take Control in 2013

Kentin Waits — Wed, 26 Dec 2012 11:36:32 +0000

As the economy shows signs of life again and even the cynics concede that we might be on the road to a modest but sustained recovery, there’s no better time to take a critical look at our savings strategies and investments. So with 2013 just around the corner, let’s resolve look behind the curtain and start the New Year more motivated to save and more empowered by the knowledge of how we’re doing financially. Here are six ways to take control of your cash in 2013. (See also: 25 Small New Year's Resolutions You Can Start Today)

1. Know Where Your Money Goes

Understanding where your money goes is the first step in taking control and taming unhealthy spending habits. Resolve to track your spending dollar by dollar for 30 days to discover the patterns that undermine saving success. You’ll be surprised how little things add up to big bills when viewed monthly.

2. Choose a Savings Category

Sometimes it’s easier to begin saving (or saving more aggressively) if we take it one category at a time. Start by reviewing parts of your budget like entertainment expenses, cell phone plans, or insurance coverage to see where there are opportunities to cut, consolidate, or get better rates. Review only one category every month and by the end of 12, those incremental changes will add up to significant savings.

3. Set Goals

We’d all like to save more money, but without knowing what success looks like, it’s hard to get motivated. Decide what your concrete goals are and how much you’ll have to save monthly and yearly to reach them. Draw a line in the sand. Do you want to save $5,000 more a year starting in 2013? Supplement your 401(k) with a Roth IRA and contribute 3% of your earnings? Get specific, and don’t be afraid to modify your plans as your goals change or earnings increase.

4. Simplify, Simplify, Simplify

Often, simplicity is the biggest financial gift we can give ourselves. Review how your assets are distributed. Do you have so many accounts that you can’t effectively keep track of your assets and their performance? Do you have old 401(k) balances from previous employers that could be consolidated or rolled over to a qualifying IRA? Remember, sometimes less really is more.

Simplify what you choose to invest in, too.

Do you own intricate investment products that you don’t understand?
Invest in companies whose business models you can’t comprehend?

Complex accounting and complicated investments breed avoidance, and that puts you in a position of powerlessness. Resolve to take a critical look at where your money is parked and explore your options to consolidate, streamline, and simplify.

5. Don’t Rely on a 401(k)

401(k) plans were never meant to be the sole savings vehicle for retirement. At best, a 401(k) is an important leg of a three-legged retirement stool that's also supported by Social Security and personal savings. Review and assess your retirement strategy with special focus on after-tax money and investments that won’t be taxed upon withdrawal (assuming you meet the proper qualifying factors). As some economists are predicting inevitable tax increases across the board over the next several years, consider Roth IRAs as a hedge against potentially higher tax burdens in retirement.

6. Watch Commissions and Expenses

Broker commissions and management fees are charges that often go unnoticed by new or novice investors. These fees can vary widely. Review your quarterly statements and pay special attention to the charges incurred in all your investments to better understand the value you’re getting for your money.

Does the performance of a particular fund warrant the charge?
Would you be just as well-off in an index fund with a lower management fee?

Though anytime is the right time to turn over a new financial leaf, the New Year plots it nicely on our calendars and in our psyches. Let 2013 be the year that you reject the idea that saving and managing your money has to be complicated, time-consuming, and painful. With a little planning and old-fashioned discipline, the end of 2013 can look even brighter than the end of 2012. Good luck.

What are your financial goals for the new year? What resolutions have you made to take better control of your finances in 2013?

Written by Kentin Waits and published on Wise Bread. Read more articles from Wise Bread.

Boost Your Retirement Savings: Avoid 401(k) Fees

Michael Kling — Thu, 20 Dec 2012 10:48:37 +0000

You might not have noticed if your 401(k) plan has been charging exorbitant fees for accounting, record keeping, legal work, management, or for any number of dubious reasons. In fact, 7 out of 10 participants don't know they pay fees to their 401(k) plan provider, according to an AARP survey. When told of the fees, 6 in 10 didn't know how much they pay, and almost a third said they do not feel knowledgeable about the impact fees have on their retirement savings. (See also: How to Make the Most of Your 401(k))

A single fee may not be much, but they certainly add up over time and cut into your hard-earned retirement savings. Fees for a median-income two-earner family can reach almost $155,000 and consume nearly a third of the workers' investment returns over a lifetime, warns Demos, a progressive think tank. According to its calculations, a family with each partner earning the median income for their gender will pay an average of $154,794 in 401(k) fees over its lifetime.

Plan administrators have gotten away with excessive fees because many people don't know about them. Even if you thought to ask, you might have found the information difficult to understand.

That is hopefully changing with new rules from the Department of Labor. Regulations rolled out this year require 401(k) administrators to clearly spell out any fees and expenses for administrative services, such as legal, accounting, or record keeping.

Plan administrators must provide total annual operating expenses as both a percentage of assets and a dollar amount for each $1,000 invested. They also have to provide historical investment returns over the past 1, 5, and 10 years along with returns of similar market indexes for comparisons.

Regardless of the new reporting requirements, you can avoid paying high account fees by following a few simple steps.

Go for Low-Fee Options

Unless there's a good reason to pay a higher fee, pick investment options with lower fees. Aggressive stock funds may do well one year but rarely consistently do better than the overall stock market. Plus, their high fees eat into returns.

Use Index Funds

Index funds, which are based on market indexes, have substantially lower management fees than actively managed funds that have administrators picking their stocks or bonds — usually less than 0.5% compared to 1% or more. And more expensive funds don't return more money than index funds over the long run.

Consider IRAs

IRAs offer greater investment choices and often lower costs, although you probably should stick with a 401(k) if your employer matches contributions.

Ask for Options

Ask your human resources department or boss for more low-fee options like index funds.

Beware Special Fees

Watch out for fees for any special features, trading costs, and fees associated with insurance products like variable annuities.

Don't Borrow From Your 401(k)

This may entail a service fee. Borrowing from your retirement fund is generally bad idea anyway and should only be a last resort.

Use Online Tools

Online tools, such as AARP's 401(k) fee calculator, can help you compare costs to other 401(k) providers. If costs seem exorbitant, point that out to your HR department or consider an IRA.

Unfortunately, new rules don't require plan providers to show how costs impact your savings over the years or require them to compare their fees to other plan administrators. The hope is that greater knowledge and increased transparency will increase competition and drive down costs.

Written by Michael Kling and published on Wise Bread. Read more articles from Wise Bread.

From Beanie Babies to Baubles: 5 Unconventional Investments

Michael Kling — Mon, 17 Dec 2012 10:48:37 +0000

If you're bored with stocks and bonds and seeking a taste of the exotic, you might be interested in unconventional investments.

Unconventional investments can help protect you against stock market volatility because they don't drop — and might even rise — when stocks sink. At least that's the theory, anyway. And if you're lucky or savvy, an alternative investment can produce an outsize return.

On the other hand, many unconventional investments are illiquid — you can't quickly sell them for quick cash. Many are risky and difficult for ordinary folks to understand. For that reason, it's best to allot only a small part of your savings to unconventional investments and to carefully analyze potential risks.

Here's six top unconventional investments. (See also: 7 Great Investments for First-Timers)

1. Collectibles

If you buy collectibles, you can invest in something you love and understand. But you might end up owning a lot of stuff and not really making money. Knowing how much someone will pay for a collectible several years from now is hard to predict. Consumers are fickle and fashions change. What's a hot collectible now may latter be just another yard sale item. Remember Cabbage Patch kids?

If you want to invest in collectibles, say wine, stamps, or baseball cards, buy only what you understand well — ideally what you're expert in. Try to be realistic about how much an item will sell for in the future.

The danger of collectibles is that they can be stolen, lost, or destroyed. You might consider insurance or a safe deposit box, but those costs diminish your profit. Owning artwork you hope to sell for a gain may end up costing money.

2. Jewelry

Some jewelry owners do make great profits reselling jewelry, but they're experts selling very high-quality gems. Most jewelry appreciates very little or nothing at all. Even though gold has increased greatly in years, you might not get as much as you hope when selling gold jewelry. Buyers take a sizeable cut, and the price is based on the jewelry's gold content, which may be lower than you expect. Most people, experts warn, should buy jewelry for its beauty and avoid it as an investment.

Some people argue that jewelry and collectibles are not real investments, as they don't make money for you while you own them — what's called an internal rate of return. A condo can generate rent. Stocks can generate dividends. But a diamond just sits there looking pretty until you sell it.

3. Precious Minerals

How about some uranium or palladium? You can invest in almost anything by owning a specialized exchange traded fund (ETF). Like mutual funds, ETFs are baskets of assets but can be traded throughout the day like stocks. Typically tracking an index, ETFs can hold anything from biotech firm stocks to utilities to currencies to bonds from small countries you can't pronounce. Some are even designed to increase in value when stock markets fall. They can track gold, silver, platinum, natural gas, oil, or uranium to name a few, as well as baskets of different precious metals.

While ETFs, which boast low costs and tax efficiency, have plenty of supporters, critics say they more like speculating than investing, have high trading costs, and don't offer diversification.

4. Frontier Investing

If you're fearless as Davy Crocket, you might consider investing in frontier markets — countries like Romania, Kenya, or Pakistan. Don't laugh. Not too long most people thought buying shares of companies in Brazil, Russia, India, and China was dangerous, but those who did garnered robust returns and now investing is those countries, the so-called BRICs, is considered quite normal. Countries like Columbia and Vietnam, often blessed with a growing middle class, may soon graduate from the frontier and into a group with catchy acronym.

Rather than traveling to Tanzania or Indonesia yourself, you can put money into a mutual fund or ETF specializing in frontier markets.

Real estate investment trusts, or REITs, own commercial properties like office buildings and shopping centers and pay dividends based on rents they collect. As their name indicates, non-exchange traded or non-traded REITs are not traded on stock markets. They are supposed to be more stable than publicly traded REITs because their values don't gyrate with the stock market, and they are not hurt by interest rate swings because rents they get are set for years.

However, financial regulators warn that their shares are illiquid and can't be easily traded. They are more difficult to value, and fees for selling can diminish your returns. Money you think you're getting as a distribution may actually be funds the REIT is borrowing or your principal being returned. Make sure you do your homework, and read its prospectus and its SEC filings to avoid being burned.

5. Peer-to-Peer Lending

In peer-to-peer, also called person-to-person or social lending, you lend money to other people through websites, such as Prosper or Lending Club. Instead of lending to a government by investing in bonds, you lend to other people by investing in online listings. You review their criteria like debt-to-income ratios and credit scores, pick loans to your liking, decide how much of the loan you'll fund, and then get part of the monthly payment after the online intermediary takes its portion.

P2P networks say they provide investors better returns than typical fixed-income investments and less volatility than stocks. That depends if borrowers you pick repay their loans.

Lending to strangers, some with imperfect credit histories, is certainly risky. Tips: Spread loans around to many different borrowers, start slowing by initially lending only to the highest-rated borrowers, and don't expect to P2P lending to be a main income source.

Written by Michael Kling and published on Wise Bread. Read more articles from Wise Bread.

Investment

2 Investing Concepts Everyone Should Know

Compound Interest

Asset Allocation

7 Investing Lessons From the Two Comma Club

1. Develop the Habit of Saving

2. Have a Purpose

3. Learn and Get Help

4. Stay the Course

5. Make Sacrifices

6. Surround Yourself With Like-Minded People

7. Once You Get There, Stay There

Best Money Tips: How to Safely Invest Your Money

Top 5 Articles

Other Essential Reading

4 Ways Your IRA Beats Your Savings Account

Retirement Assets Are Not Included in Calculations for College Aid

Tax Benefits Are Available With Retirement Accounts

Retirement Accounts Enjoy More Protection

Retirement Funds Are Off Limits for Regular Expenses

Why Canada’s TFSA Is Totally Awesome

TFSA 101

Tax-Deferred Versus Tax-Free

Why the TFSA Is Totally Awesome

6 Valid Reasons Not to Contribute to Your 401(k)

1. Your Company Doesn’t Match Your Contributions

2. You Plan to Leave the Company After a Couple of Years

3. You Want to Pay Off High Interest Debt

4. Your Employer Offers a Lousy 401(K) Plan

5. You Need Cash to Make a Down Payment on a House

6. You Want to Fund a Roth IRA

How to Set Up an IRA to Build Wealth

Step 1: Traditional or Roth?

Step 2: Which Company?

Step 3: Which Fund?

Step 4: Contribute Regularly

6 Ways to Get Paid for Saving Money

1. Claim the Saver's Credit

2. Win Prizes and Rewards for Saving Money

3. Earn Bonuses for Setting Aside Money in Savings Accounts

4. Get Cash for Opening and Funding an Investment Account

5. Snag Your Company's Match

6. Take Tax Deductions

The False Allure of Compound Interest

Things Change

Returns Are Back-Loaded

Women: How and Why to Take Charge of Your Finances

Make a Budget

Forget What You’re “Not Good” At

Get Educated

Make Sure Your Financial Education Is Comprehensive

Focus on Goals

Do It

Intro to 5 Super Safe Investments

What Makes Investments “Safe”?

1. Savings Account

2. Certificate of Deposit

3. Money Market

4. Treasury Securities

5. Annuities

Bottom Line

A Guide to Online Brokers for Investing Newbies (and Beyond)

Background

Ways to Evaluate Brokers

How to Choose an Online Broker

Money Resolutions: 6 Ways to Take Control in 2013

1. Know Where Your Money Goes

2. Choose a Savings Category

3. Set Goals

4. Simplify, Simplify, Simplify

5. Don’t Rely on a 401(k)

6. Watch Commissions and Expenses

Boost Your Retirement Savings: Avoid 401(k) Fees

Go for Low-Fee Options

Use Index Funds

Consider IRAs

Ask for Options

Beware Special Fees

Don't Borrow From Your 401(k)

Use Online Tools