Interesting chart from thechartstore.com, via Jeffery Saut with Raymond James. It takes an average wage earner 6.8 hours of work to 'buy' a barrel of crude oil, almost a 300% increase from five years ago. Yet the Government sees little inflationary pressures on the average American.
Source:
'Investment Strategy'. by Jeffery Saut, Raymond James
With the election season in full swing, the plight of the middle class America has taken center stage. The past decade has not been a great for the middle class in America with the continued loss of jobs, the technology stock crash, the mortgage bubble popping, inflation, lack of affordable health care and stagnant wages.
The American worker's salary has not kept up with the rising cost of living. Between 2000 and 2006, the average family's income dropped 4.0%, while inflation increased by 17%. What cost a dollar in 2000, would now cost $1.17. However if you look at the cost of some basic items that a family uses on a daily basis, these prices increased at a faster rate than the overall inflation rate. A pound of ground beef has increased in price by almost 40% while a gallon of gasoline has increased by almost 80%.
Below is a graphic from an article in the WSJ about the middle class, and specifically about their roll in deciding the Pennsylvania Democratic primary. This is an issue not just isolated to Pennsylvania, but across the states. 'In a recent Pew Research Center survey, 41% of respondents rated their lives as better than five years ago, and 31% said they were worse. That response is even glummer than in 1979, when, amid rising economic malaise, 25% of respondents to a similar survey rated their lives as worse.'
Expect to the politicos to focus on this through November.
Source:
'Trapped in the Middle', by Justin Lanhart and Kelly Evans, WSJ {$$$}
April 23 of 2008 is Tax Freedom Day. This means that it took Americans about four months of work to make enough money to pay their tax obligations (federal, state & local) for the year. We achieved freedom three days earlier than last year due to the economic slow down and the stimulus package.
Source:
'America Celebrates Tax Freedom Day', by Tax Foundation, taxfoundation.org
'Special Report No 160', by Gerald Prante and Sctoo A Hodge, Tax Foundation
A paper published by Jeffery A Busse and Qing Tong, of the Goizueta Business School at Emory University, explains that for consistent performance in a mutual fund its better to have a manager who can pick industry sectors than one who can pick stocks. The paper explains 'that industry selection contributes substantially to fund performance, accounting for roughly half of a fund's abnormal performance.' The paper states that this importance of industry selection is 'stable across time, with little year-to-year variation in the mean contribution across funds.'
The paper is based on analyzing almost 4,000 actively managed domestic mutual funds from 1980 to 2006. The researchers analyzed a manager's industry selection ability by setting up a hypothetical portfolio which replaced each stock in the fund with an index for that stock's industry. For example if a manager bought Johnson and Johnson, the researchers added an equal dollar amount of an index representing major drug manufacturers. If the hypothetical portfolio beat the market, the manager was showed to be good at industry selection. If the manager's stock picks outperformed the hypothetical portfolio, the manager was judged to be good at stock selection.
Based on the analysis, the researchers found that a manager's margin for beating the market was split almost evenly between stock selection and industry selection. However, over a longer period of time, industry selection was a skill that would most likely persist. The paper also found 'a negative relation between fund portfolio size and stock-selection skill'. This 'negative relation' was not present when comparing the size of a fund and industry selection. This fact probably explains why some large mutual funds preform quite well, while others suffer.
Below is a chart comparing Fidelity's Magellan Fund (market cap $38.40 billion) to American Funds Growth Fund of America ($165 billion). Between 1977 and 1990, the Magellan Fund, under the management of Peter Lynch, had an annualized returned of 29%. The fund ran into problems in the late 90's when the funds asset base swell to $100 billion dollars and ended up a 'closet' index fund. As the fund grew, the manager was unable to put that money to work effectively. Stock selection which had been the strong suit of the fund's new manager broke down under the weight of its asset base.
Dollar cost averaging or lump sum, which is the best approach for an investor. The unequivocal answer is either one depending on your situation.
Basic Investment Strategies
Below is a brief explanation of the two investment strategies. Have also thrown in another strategy that is similar to dollar cost averaging.
Dollar Cost Averaging (DCA) is defined as the investment strategy of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high. An example of this type of investing is to purchase $1,000 of shares each month to in a mutual fund for a total of $12,000 over a year.
Lump Sum Investing (LSI) is defined as the investment strategy of buying a particular investment at one time. An example of this type of investing is entering in an order to purchase $12,000 worth of shares at a single time. Typically additional purchases would not be made in a significant amount.
Value Averaging (VA) is defined as an investing strategy that works much like dollar cost averaging (DCA) in terms of steady monthly contributions, but differs in its approach to the amount of each monthly contribution. In value averaging, the investor sets a target growth rate or amount on his or her asset base or portfolio each month, and then adjusts the next month's contribution according to the relative gain or shortfall made on the original asset base. An example of this type of investing is to start by purchasing a set number of shares, and over a period of a time purchasing additional shares each month so that the account value equals $12,000. The number of shares would vary depending on the price of the shares. Months when the price is lower than the intital purchase price, more shares would be bought and the opposite when prices are higher.
Which Strategy Yields The Best Returns?
Using historical data to compare the DCA strategy to the LSI strategy, the LSI method returns higher results 2 out of 3 times. Here is a tool that allows you to test the two methods for each month of the year since 1950. LSI has the advantage since the overall trend of the stock market has been to increase in value year to year. In a rising stock market, DCA is hurt by the fact that with each purchase the cost basis of the shares increases while the LSI cost basis remains constant. Typically in a market that is in a down trend, the DCA strategy comes out ahead because with each purchase the cost basis is lowered.
Below is a chart from AllFinancialMatters.com, that compares DCA strategy to LSI strategy. The LSI strategy (account value) took $19,900 and invested in the Vanguard S&P 500 Index fund on January 2, 1990. The DCA strategy invested $100 at the begining of each month from January 2, 1990 to July 3, 2006, which works out to a total of $19,900 (199 months multipled by $100 each month).
Practical Advice
If you come into a large amount of money and want to invest it, you are better off putting it on all at one time. First is the evidence clearly shows that in most cases you will come out ahead by lump-sum investing. Secondly if you invest it all at one time, you will not be tempted to spend it.
Most of us cannot afford to take a large sum of money at one time and invest it, by default we have to dollar-cost average. An employee sponsered retirement plan (401K or 403B) is a perfect example of dollar-cost averaging. If this is the only way that you can afford to invest, this is your best option.
Source:
'Dollar Cost Averaging', Investopedia.com
'Value Averaging', Investopedia.com
'Dollar Cost Averaging v. Lump Sum Investing - Part II', by JLP, allfinancialmatters.com
'Lump Sum Beats Dollar-Cost Averaging' by Richard E. Williams, Ph.D., and Peter W. Bacon, DBA, CFP, Journal of Financial Planning
There is a ton of information and advice out there on how to build wealth. It seems that some people try to attain wealth by developing a 'system' on how to be rich, then write a book on the 'system' and finally give seminars on how the 'system' works. A long the way there are plenty of opportunities for selling 'system' merchandise. The problem with this is that each 'system' needs a little different angle to make it stand out from all the other stuff out there. All of these different angles end up creating a lot of noise and confusion, when really most systems talk about the same basic things.
I guess if I were to write a book on how to build wealth I would write about these six pieces of advice. Eventually I will have to come up with a fancy buzz word, which would be trademarked, to describe my powerful wealth building system, but these things just seem like common sense.
Just think, I have already started you on your way to building your wealth. By finding this you just saved $9.99 plus tax for my book.
1. Start Now
The sooner you start to invest the better your long term returns will be due to the power of time (and compounding). Time is one of the best investment tools you will ever have. Below is a chart, from AG Edwards, that compares an early saver and a late saver. The early saver deposits $250 a month for 10 years for a total investment of $30,000, while the late saver waits 10 years and then begins to deposit $250 a month for 30 years for a total investment of $90,000. Assuming an 8% compounded return and ignoring taxes, at the end of 40 years the early saver has $88,000 more than the late saver. If the earlier saver continued to save $250 a month for the entire 40 years the difference between the two savers would be much greater.
Don't worry about the hottest stocks or sectors to be in. Don't worry about not having enough money to begin. Don't worry about being too young or too old. Don't worry about how much you need to save. Just start.
2. Compounding is Your Friend
Albert Einstein has been quoted as saying "The most powerful force in the universe is compound interest." In the case of investing in stocks and mutual funds you are really compounding your returns, but the idea is similar to compound interest. As you reinvest your dividends and capital gains distributions back into your stocks or mutual funds, this reinvestment generates additional earnings which grow year after year. Below is a chart, from Bankrate.com, showing that if at age 25 you started to put $100 per month into an account that returns 6% each year that you would have $200,145.
Source: Bankrate.com
The great thing about compounding is that the growth you get from reinvesting the dividends and capital gains distributions will start to outpace the return you get from your initial investment. Think of it as a small snowball rolling down a mountain. As the snowball rolls down the hill it picks up more and more snow, building in size. At the bottom of the mountain the snowball has grown in size to a massive one (a bit of an exaggeration but you get the idea). Eventually you reach a point where your money is working for you to create more money. This is the 'holy grail' for investors.
3. Your Only Average
You should just come out and say this 'I am not as good of an investor as I think I am'. Numerous studies have been performed showing that people tend to be overly optimistic when it comes to investment decisions. This over optimism leads people to sell their winning investments too soon and hold onto their losing investments too long. If you are able to take the emotion out of your investing, and accept that you are only average you will come out ahead of many others. From a NY Times article:
Stocks have been a great investment in the last 80 years, with an average return of about 10 percent a year. But have investors in the stock market done as well as stocks? Surprisingly, the answer is no. The average dollar invested in the stock market in those years has earned only about 8.6 percent a year.
The article references a paper published by Ilia D. Dichev, a University of Michigan accounting professor, that explains the difference due to investors buying patterns. The article provides an example:
To understand the difference between a stock’s return and an investor’s return, consider someone who buys 100 shares of a company at a price of $10 a share. A year later, the share price is up to $20, and the investor buys 100 more shares.
Alas, the investor’s luck has run out. By the end of the next year, the price has fallen back to $10 and the investor sells his 200 shares. A buy-and-hold investor who bought at $10, held the stock for two years, and then sold at $10 would have had a zero return.
But our friend who tried to time the market did much worse: over the two years, he invested $3,000 in the stock and ended up with only $2,000. Even though the stock broke even, the investor lost money because of bad timing: most of his money was invested right before the market fell.
To calculate a meaningful measure of the investor’s return, it is necessary to weight the yearly returns by the dollars invested during that year. When Mr. Dichev calculates the dollar-weighted returns on this stock according to his preferred method, our hypothetical investor’s average yearly return ends up being negative 26.8 percent, far below the zero return that the buy-and-hold investor would have received.
4. Invest for The Long Term / Invest Through All Markets
Shorter time periods in the stock market are very volatile, however the general trend for most stock markets has been in an upward direction. The market will fluctuate from day to day, month to month and year to year, the market can not be up making a new high everyday.
Above is a chart of the S&P 500 starting in 1950 through today, compared to the 10-year US Bond. Since 1950 there have been 12 bear markets with an average loss of -26%. Over the same period the S&P 500 has returned over 7,500%. During those 12 bear markets it probably seemed like the world was ending, however the market rebounded from these events. Granted markets do not go up all the time and there maybe periods of under performance, however being invested in the stock market is a great way to build wealth.
5. Keep It Simple, Be Lazy
There is no need to spend a lot of time developing a complex portfolio of stock, bond and mutual fund holdings. The easiest way to be invested in the market and to be diversified is to invest in a Life Style or Target Retirement fund. These types of funds are a one-stop-fund that invest in a basket of stock and bond mutual funds, shifting overtime from more stocks in the early years to more bonds as the 'target' age is reached. These funds will even re-balance as needed to maintain their asset allocations, all you would need to do is fund the investment. Granted these types of investments are not a lot of fun to talk about at a cocktail party, but in the long run they will save you time, effort and worry. Below is a chart comparing a very simple portfolio (Second Garder's Starter), a target retirement fund (T Rowe Price 2040 Fund) and the S&P 500.
| Portfolio | Equity % | 1 Year Return (3) | 3 Year Annualized Return (3) | 5 Year Annualized Return (3) | |
| Second Grader's Starter (1) | 90% | 8.83% | 12.31% | 17.02% | |
| S&P 500 (1) | 100% | 5.49% | 8.62% | 12.83% | |
| T Rowe Price 2040 Fund (2) | 91% | 6.67% | 10.31% | 14.76% |
1) Source: Morningstar Inc
2) Source: T Rowe Price
3) Returns as of 01/03/2008
For more information see my posts on being a lazy investor, part one and part two.
6. Make It Automatic
Sign up for an automatic investment plan. The most common of these plans is a 401K or other employee-sponsored retirement plan you might find at work. These plans work by automatically taking money from your pay check and investing them into your account. You don't even get a chance to spend the money. You are paying yourself first.
Another great thing about automatic investment plans is that you are dollar-cost averaging (DCA). Dollar cost averaging is a 'technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high.'
There is some controversy about DCA and that it is nothing more than a marketing gimmick. Some studies have shown that over 'long periods, dollar-cost averaging almost always produces lower returns than investing lump sums in diversified portfolios, and almost never reduces risk meaningfully.' The studies are correct, if one were able to invest lump sums they would come out ahead, but who has a nice lump sum sitting around?
Probably the most important lesson to take away is that it takes discipline and commitment to build wealth. Very few people are lucky enough to win the lottery, to have developed and marketed a must-have gadget or worked hard starting their own company which has been bought out for millions of dollars. Most of us have the save and invest diligently, live within or means and let time help us out. But it is possible if you just start now.
Source:
'Sometimes the Stock Does Better Than the Investor That Buys the Stock',by Hal R Varian, New York Times
'Dollar-Cost Averaging', Investopedia.com
'The costly myth of dollar-cost averaging', by Timothy Middleton, MSNMoney.com
Seems that the period from 1998/1999 to today has been a terrible time to be either an employee or a stock investor.
Wages Down
The graph below is from a NY Times article talking about how many Americans did not get a head during the boom of the last decade. At the end of 2000 the median (or typical) American Family made about $61,000. At the end of 2007 the estimated median income was $60,500. These numbers are from the Census Bureau and have been adjusted for inflation via the NY Times article.
The article goes onto explain that, "(t)his has never happened before, at least not for as long as the government has been keeping records. In every other expansion since World War II, the buying power of most American families grew while the economy did.'
'More than anything else — more than even the war in Iraq — the stagnation of the great American middle-class machine explains the glum national mood today. As part of a poll that will be released Wednesday, the Pew Research Center asked people how they had done over the last five years. During that time, remember, the overall economy grew every year, often at a good pace."
"Yet most respondents said they had either been stuck in place or fallen backward. Pew says this is the most downbeat short-term assessment of personal progress in almost a half century of polling.'
The average American family has also been battered around by the end of the technology bubble in 2000 and the collapse of the housing market in 2006/2007. They have also had to deal with increases in food and gas prices making it hard to feed a family and fill up the car. No wonder the outlook is so downbeat.
Stocks Down
Below is a graph from a WSJ article talking about the stock markets lost decade. Since 1999, the S&P has returned just 1.3% a year over the past decade. This return takes into account inflation and dividends. You would have made more money by investing in the US Long-Term Treasury Bonds (7.68%) over the same period.
The article explains some of this under-performance due to after a period of "extraordinary returns, as we did from 1982 through 1999, then usually the next 10 years aren't very good," says Prof. Sylla. His research suggests that exceptional booms steal gains from the future. When the booms end, returns become subpar, so that average returns over the longer term fall back to the 7% norm. Economists call this "reversion to the mean," the idea that exceptional performance can't last forever.'
Don't look for a quick recovery either:
"We have to accept that this is no longer a nation of 4% real economic growth. This is a mature nation that no longer has a strong manufacturing base," says Steve Leuthold, chairman of Leuthold Weeden Research in Minneapolis. He believes that another bull market is on the horizon, perhaps following some additional stock declines. But that future bull market, he contends, could be followed by another bear market that could bring stocks back close to where they are today."
"Before another lengthy bull run can begin, stocks need to overcome two problems: the hangover from the high prices of the late 1990s, and the continuing effects of the exceptionally low interest rates instituted by the Federal Reserve in 2001 and again today. Those low interest rates helped push corporate profits higher, but also fueled borrowing excesses that led to today's economic problems."
Both articles are a good, if depressing, read.
Source:
'For Many, a Boom That Wasn’t', by David Leonhardt, NY Times
Stocks Tarnished By 'Lost Decade', E. S. Browning, WSJ {$$$}
Read in the WSJ that after 26 years as a journalist Jonathan Clements is retiring. He has decided to take his mom's advice and is getting a real job, although he doesn't go onto explain what that real job will be.
His last article asks "What is the reason for all this saving and investing?" He provides three key benefits.
1. If you have money, you don't have to worry about it. This isn't guaranteed. There are lots of rich folks who agonize constantly -- and needlessly -- about their finances. Still, if you save diligently, you should reach the point where money worries are relatively rare.
This feeling of financial serenity isn't, however, only for the wealthy. If you live beneath your means and invest prudently, you can achieve a sense of financial control long before you achieve full financial independence.
As I see it, this is yet another reason to follow my favorite investment strategy, which is to build a globally diversified portfolio of low-cost index funds.
If you are diversified, you don't have to fret about your wealth imploding because of a few disastrous stocks or a single rotten market. And if you buy index funds, you don't have to worry about badly lagging behind the market averages because you or your fund managers pick the wrong stocks.
2. Money can give you the freedom to pursue your passions. Ideally, you want to spend your days engaged in activities that you find absorbing and satisfying, that you feel you're good at -- and where you feel you're doing good.
Indeed, the happiest retirees are typically those who have a sense of purpose, whether it's volunteering for their pet cause, coaching a children's sports team, helping their church or returning to long-neglected studies. Retirement gives them a chance to pursue their passions without worrying about a paycheck.
But again, you don't need to be financially independent to have a sense of purpose. If you're young, you can pick a career that is close to your heart. If you're in your 40s and you have been saving for 15 or 20 years, maybe you can afford to swap into a new job that is less lucrative but more fulfilling.
3. Money can buy you time with friends and family. You don't just need a reason to get up in the morning. You also need somebody to come home to at night.
Studies have found that regularly seeing friends and family can provide a huge boost to happiness. Money helps in this regard, allowing you to go out to dinner with neighbors, travel to see old friends, take your family on vacation and go to the theater with your spouse. If you don't need to work or you only work part time, that will help further, giving you more hours to share with the folks you like best.
I have always enjoied reading Mr Clements articles. He has some keen observations on personal finance and how to build your wealth.
Source:
'Parting Shot: What I Learned From Writing 1,008 Columns' , by Jonathan Clements, WSJ {$$$}
Back in the 60's most people went to work for one compay and stayed with that company until they retired. Today the job market seems to be constantly changing. The U.S. Department of Labor figures show that the youngest baby boomers (ages 42–49) have, on average, held more than 10 different jobs during their careers.
Below is a chart From Charles Schwab listing the options you have when it comes to your 401K plan:
Option | Pros | Cons | |
| Roll over to new employer's plan |
|
| |
| Roll over to an IRA |
|
| |
| Leave in former employer's plan |
|
| |
| Take a cash distribution |
|
|
Source:
'Managing Your Finances When Changing Jobs' , by Charles Schwab & Co., Inc.
Probably one of the biggest tasks for anyone managing their personal finances is how to manage all of the paperwork associated with the accounts. It seems that each account generates about 15-20 statements or mailings a year. If you have several accounts, by the end of the year you could have a pile of papers stacked up waiting for you to deal with them.
How do you know which pieces of paper to keep and which to discard? How long do you need to keep the paperwork for? Where should you store everything? Hopefully, this post will be you begin to organize you financial paperwork.
First Contact
When you get the mail this is your first chance to help organize you financial paper work. Take a few minutes to review the mail and discard any random catalogues or mailings that are not addressed to you. These mailings typical are addressed to 'Our Neighbor", 'Resident' or some other pleasant nondescript word. Next pass is to separate the personal letters, bills and account statements from other pieces of mail actually addressed to you. Open the bills and account statements and get rid of any extra paperwork (advertisements, the used envelops) included in the envelop. I can't tell you how many advertisements I have thrown out after opening a credit card bill. Once you go through this step put the actual bills and account statements in an In Box so you can deal with them later.
On the final pass through the mail, go through and discard any other random mailing you are not interested in reviewing further. It is best to review anything I have pulled out soon after doing this. If not I will usually let it sit around until I throw it away. A good thing to do is to shred any credit card applications or other things that have personal information. Can't be to careful about identity theft, read my post on identify theft.
In Box
The In Box can be anything you want; a box, a bin, a file folder, an envelop, etc. just as long as it's only use is for mail you need to deal with. Depending on the type of person you are, you may empty out the In Box everyday or twice a month. Some people may want to deal with everything in one sitting, while others may stretch it out over a couple of days. Whatever works for you is what you should do, as long as it is consistent. As you go through and resolve the items in your In Box, send them to the Out Box.
Out Box
Just like the In Box, the Out Box can be anything you want, just as long as it's only use is for the mail you need to file. Again, you can determine when to empty your Out Box on a schedule that works best for you. I usually skip this step and after dealing with the In Box and go directly to file.
File
At this point, you can separate bills from account statements. Bills get put into a folder and kept until the next monthly bill. You should verify that the previous months payment was credited correctly and then shred the old bill. Quite a few people may want to keep their monthly bills, I am just not one of them. If you want to keep you monthly bills, it would be best to keep an expanding file with a minimum of 12 sections, with each section representing a month. Some bills you may need to keep to help determine the cost basis when you sell the item, or if you need to prove the value of an item for insurance purposes.
Account statements get filed in a three-ring binder with tabbed sections, each tab representing a individual account. Some accounts (bank accounts/trading accounts) produce just monthly statements, so you should keep each of those. Other accounts (401k accounts/mutual fund accounts) produce monthly, quarterly and/or yearly statements. In terms of keeping the amount of paperwork to a minimum you should just keep the statement with the longest time period. For example if your mutual fund company issues all three types of statements, just keep the yearly statements.
Sometimes you may need to keep some random or loose items that are shaped a little strangely. You can always add zipper binder pocket to store those items.
Archive
Three ring binders can be expensive and sometimes take up a lot of shelf space, so after a year you can transfer the statements into a pressboard binder. You can transfer all the statements along with the divider tabs into these binders and store them somewhere. It would be good to write the year on the front cover of the binder.
You can also store your binders in boxes to free up space in the bookshelf.
Last Contact
How long do you need to keep your financial records? Check out this post which covers which financial paperwork to keep and for how long. Once you have determined that the documents are no longer required, you should destroy them by shredding. Most of these statements have sensitive information that you may not want others to be able to see.
Electronic Storage
A lot of financial companies offer the opportunity to receive your statements electronically or the ability to download them in PDF. Some companies even charge you for a paper statement. The question is, should you keep hard copies of your financial records if you receive electronic copies?
One huge benefit to electronic statements is that your paperwork is greatly reduced. You would still need to be organized, but it can be easier to 'file' electronic statements then it is to file paper statements. One huge problem with only electronic statements is what happens to all of your information if your computer crashes? I think that it is best to either have a paper copy or back up the disk drive often.
I think that for most types of accounts, paper statements will eventually go the way of the checks bank use to return to you. Most companies would prefer to do this. Just think of the money they could save by not having to print and mail documents to account holders. I still like to have a paper copy of account statements. Mainly because I will spend more time reading them then if I have to review them on the computer.
Reduce
One way to help reduce the amount of paperwork you have to deal with is to remove you name from mass mailers and pre-approved credit card offers. Not only will this reduce your hassle factor you will do something good for the planet. Here are a couple of facts about junk mail from The Center for a New American Dream.
Below are some links to use to reduce your junk mail.
Source:
'Just the Facts: Junk Mail Facts and Figures', New American Dream
While it may not be necessary to keep every bill, receipt or statement, there are a couple that are worth holding on to:
Income Tax Returns
You should save all of your paperwork related to you Federal tax return for a minimum of three years. The IRS has up to three years from the filing date to audit your tax return, and in some cases has up to 6 years. Depending on the complexity of your tax return, this could be a rather large amount of paperwork. You should check with the state that you also file taxes in to see how long they have to audit your return.
W-2 Forms & Other Income Statements
You should retain these for as long as you keep your income tax returns. Also every year you should compare your last W-2 statement to your Social Security Statement earnings record. These statements are sent out to anyone over 25 years of age and with earned income around their birthday. For more information check out this link.
Brokerage/Mutual Fund Statements
Keep these documents for as long as you have the money invested in the accounts. This will allow you to calculate your cost basis at any future sale. Once the investment has been sold, the documents should be retained for as long as you keep your tax return for the year in which you sold the investment. If you are applying for a loan, part of the application process may require that your provide copies of your Brokerage/Mutual Fund statements.
Bank Statements
Depending on your comfort level, you could keep these for as short as it takes you to balance the account. The general advice for holding onto these statements is to keep them for at least a year. If you are applying for a loan, part of the application process may require that your provide copies of your bank statements. Again, anything related to income tax returns should be kept for up to three years.
Receipts
Keep receipts for all big ticket items, like jewelry, computers, cars, boats, appliances and home improvements. These records will help you prove the value of these items in case of loss or damage. For certain items, like home improvements these records should be kept for as long as you own the item. These costs can be used to help determine the cost basis if you need to report a capital gain or loss on the items.
Bankrate.com has a good article on additional items which should be saved on for how long.
Source:
'Publication 552 (2005), Recordkeeping for Individuals' , IRS
'Publication 523 (2007)', Selling Your Home', IRS
'What financial records to keep, how long to keep them', Bankrate.com
The IRS gives you until April 15th of this year to make a contribution to a traditional IRA or a Roth IRA for the 2007 tax year. The 2007 limits are $4,000 maximium, and $5,000 maximium if you were age 50 or older in 2007.
The IRS also allows you to take a tax credit for eligible contributions to a qualified retirement plan (i.e. Traditional IRA, Roth IRA, 401K, 403B, 457, 501C, SEP or a SIMPLE IRA.) if your adjusted gross income is below a certain limit. You can also claim the credit before you actually make the contribution, as long as that the contribution is made April 15th.
The great thing about a tax credit it that it is a dollar for dollar reduction in any tax amount you owe, which makes it more 'valuable' than a tax dedcution. A tax deduction only reduces the amount of taxable income.
Source:
'Publication 509 (2007), Individual Retirement Arrangements', IRS
Earlier I posted about how hard work can actually hurt you as an investor. Most people, those not involved in financial markets, do not have the time, tools, skills or the experience to be really good at picking stocks or mutual funds that consistently beat the market. Even if you do invest in the market, you probably do not make as much as you think due to fees, expenses and taxes.
The Pros Can't Beat Market All The Time
Professional mutual fund managers are not able to consistently beat the market. Here is an excerpt from a Motley Fool on line article on mutual funds,
Though you would think that mutual funds provide benefits to shareholders by hiring alleged "expert" stock pickers, the sad truth of the matter is that the vast majority of mutual funds underperform the average return of the stock market. Over time, because of their costs, approximately 80% of mutual funds will underperform the stock market's returns.
In an article in the FPA Journal, Thomas McGuigan studied the returns of large-cap and mid-cap mutual funds over a period of twenty years. Their conclusion was that very few could consistently beat the market over long time periods. Their study also showed that it was impossible to predict which funds would outperform their index. I guess that is why every investment advertisement says that "...Past performance is not a guarantee for future returns."
Below are tables comparing large-cap and mid-cap with an index fund. The large-cap funds were compared to the Vanguard 500 Index Fund. For mid-caps, there was no mid-cap index fund present over the entire study period, so a proxy index fund was created for the study.
The data in the table reflect four main findings:
How To Beat The Pros
Be lazy, don't invest in individual stocks or actively managed funds. Don't pay attention to Wall Street, CNBC or any Get-Rick-Quick investment schemes.
All you need is a portfolio of just three index funds and you could have beat the S&P 500 last year along with beating it over the past three and five year periods. Below is a chart comparing three portfolios: Second Grader's Starter, S&P 500 and T Rowe Price's 2040 Retirement Mutual Fund. I wanted to throw a retirement/lifestyle fund into the mix to provide a better compassion to the Second Grader's Starter portfolio.
| Portfolio | Equity % | 1 Year Return (3) | 3 Year Annualized Return (3) | 5 Year Annualized Return (3) | |
| Second Grader's Starter (1) | 90% | 8.83% | 12.31% | 17.02% | |
| S&P 500 (1) | 100% | 5.49% | 8.62% | 12.83% | |
| T Rowe Price 2040 Fund (2) | 91% | 6.67% | 10.31% | 14.76% |
1) Source: Morningstar Inc
2) Source: T Rowe Price
3) Returns as of 01/03/2008
The Second Grader's Starter was developed by Allan Roth, a Colorado Springs CPA, for his 7-year old son in 2004. Allan developed a portfolio of just three Vanguard mutual funds, Total Stock Market Index, Total International Stock Index and the Total Bond Market Index. This portfolio has four huge advantages for it:
The suggested portfolio breaks out as follows, depending on your risk tolerance.
Investment | High Risk (1) | Medium Risk | Low Risk | |
Vanguard Total Stock Market Index VTSMX | 60% | 40% | 20% | |
Vanguard Total Intl Stock Index VGTSX | 30% | 20% | 10% | |
Vanguard Total Bond Market Index VBMFX | 10% | 40% | 70% | |
Totals | 100% | 100% | 100% |
1) This was the fund allocation used in the Second Grader's Starter Portfolio noted above.
Other Lazy Portfolios
In 2004, Paul B Farrell published 'The Lazy Person's Guide to Investing: A Book for Procrastinators, the Financially Challenged, and Everyone Who Worries About Dealing With Their Money', which showed the benefits of a simple, easy to maintain and understand portfolio of mutual index funds. Currently he writes for Marketwatch.com and has been tracking several 'Lazy Portfolios':
Portfolio | Equity % | # of Funds | 1 Year Return (1) | 3 Year Annualized Return (1) | 5 Year Annualized Return (1) | |
| Aronson Family Taxable | 80% | 11 | 13.54% | 16.23% | 21.47% | |
| FundAdvice Ultimate Buy & Hold | 60 | 11 | 6.93% | 14.44% | 20.32% | |
Margaritaville | 67 | 3 | 10.51% | 14.01% | 18.63% | |
| Yale U's Unconventional | 70 | 6 | 2.78% | 12.08% | 18.12% | |
| Dr. Bernstein's Smart Money | 60 | 9 | 3.72% | 11.43% | 17.75% | |
| Dr. Bernstein's No-Brainer | 75 | 4 | 6.79% | 11.59% | 17.47% | |
| Second Grader's Starter | 90 | 3 | 8.83% | 12.31% | 17.02% | |
| Coffeehouse | 60 | 7 | -0.23% | 9.75% | 16.71% | |
| S&P 500 | 100 | n/a | 5.49% | 8.62% | 12.83% |
1) Returns as of 01/03/2008
The portfolios vary in complexity, both in number of funds and in amount of maintenance required, and in returns. One of the main points that gets repeated over an over is to take the emotion out of your investment decisions and re-balance. The article quotes Ted Aronson, AJO Partners' founder and developer of the Aronson Family Taxable portfolio,
Now comes this year's big lesson: Aronson warns that most investors will psychologically resist selling the big winners and buying lesser performers. But that's what re-balancing and "Modern Portfolio Theory" (the theory behind Lazy Portfolios) is all about. You stick to your asset allocations as sector performance waxes and wanes over the long-term. Otherwise you're just chasing hot sectors and engaged in high-risk market-timing
Really Really Lazy Portfolios
For some people, having to invest in three funds and then re-balance every year is still too much work. Not to worry, mutual fund companies have developed Life Style or Target Retirement funds. These funds are a one-stop-funds that invest in a basket of stock and bond mutual funds, shifting overtime from more stocks in the early years to more bonds as the 'target' age is reached. These funds will even re-balance as needed to maintain their asset allocations, all you would need to do is fund the investment.
With this type of investment it is very important to pick a mutual fund company (Fidelity, T Rowe Price or Vanguard) that has low management fees. A minor point to look into is the asset allocation of the funds as there are some differences which may affect returns. See table below for a comparison
Investment | % of Stock | % of Bonds/Cash | Foreign Stocks as a % of Stocks | |
| American Century LIVESTRONG 2035 ARYIX | 74.9% | 25.1% | 15.8% | |
| T. Rowe Price Retirement 2035 TRRJX | 87.5% | 12.7% | 22.4% |
1) Source: Morningstar Inc
It Seems So Easy?
It is that easy. Granted there will be people who will say that these portfolios will not work, or that they can't be any good cause they are too simple. The evidence shows that these methods do work, are easy and can be very profitable. As Paul Farrell noted: "Nothing saved ... equals nothing invested ... equals nothing compounded ... equals a less than dreamy retirement".
Source:
"The Difficulty of Selecting Superior Mutual Fund Performance", Thomas P. McGuigan, CFP, FPA Journal
"Lazy Portfolios Annual Update For Recssion '08", Paul B. Farrell, Marketwatch.com
"How An 8-year Old Crafted A Simple Winning 'Lazy' Portfolio", Paul B. Farrell, Marketwatch.com
"2nd-Grader's Portfolio Takes On Wall Street", Allan Roth, CPA, The Colorado Springs Business Journal
