Making the Most of $10K When in Debt

Q. We have a 40 year old son, who has nothing saved for retirerment, no 401(k), etc. He owes $60,000 on his house which is about what it is worth (merged car loan). He will soon receive $10,000. What should he do with the money? He's receiving child support from his wife, $450. His new wife does not work, his income is around $45,000. A concerned mother, thanks.

A. The difficulty may be that there needs to be a change in behavior. There's nothing magic about building wealth. You have to live below your means and be disciplined to save. Only your son will be able to make that change and, depending on his personality, outside pressure may result in him resisting change.

In your son's situation it may be that he doesn't have enough income. If his home is only worth $60k, then he is already living modestly. $45k in income doesn't go a long ways nowadays, especially with children.

As far as what he should do with the $10k, I would recommend that he put it toward the debt on the home. If monthly cash flow is a problem, he can then refinance the $50k left on the home for 30 years. That would lower his monthly payment without adding to his debt.

Thanks for your question!

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Monthly Income

Q. Dear Jeff, Thanks for taking my question. I was forced to retire due to an accident. I made a cash settlement and need to invest in a monthly income. I can purchase a fixed annuity from Fidelity for 75,000.00 that will pay a monthly payment of 364.19. I would also like to invest in a growth fund of some sort that also pays a monthly income. What would be a good option for me to pursue?

A. Thanks for asking your question...and I'm sorry about your accident. Can you tell me a little more? What is the total amount of your investable assets and if any are already invested, how? What monthly income do you need? How old are you? This will help me narrow down a recommendation.

Q.The total amt of investable assets is 150,000.00. I am 60 years of age and my wife is 55. I need an income of five to six hundred dollars monthly to compliment my social security. I have no investments other than our home which is debt free.

A. Now that I understand your situation a little better, let's look at your investment options. You mentioned the Fidelity annuity and referred to it as a fixed annuity. Are you referring to an immediate annuity?

A fixed annuity pays you a set rate of interest for a set period of time and then you get all of your principal back. An immediate annuity is like a home mortgage in reverse. Each month you get a payment that consists of interest and a return of some of your principal. Immediate annuities guarantee the set payment amount for 10years certain, life, joint life, etc.. There is a big difference between the two.

If you can get $364/month and it be a fixed annuity, then that's a great deal---over 5.5%. That is considerably above market rates, so I expect you are referring to an immediate annuity. If so, that return is being made up by them giving you back your money and some interest. The interest rate used in that calculation is probably less than 4%. Was it an immediate, and what were the terms--10 year certain, life or joint life? Let me know and I will be able to provide some different alternatives.

Also, you mentioned wanting to invest some in a good growth fund--is that money that you wouldn't expect to touch for several years? Do you anticipate investing the full $150k or will you need some of it to pay off expenses, cash reserve, etc? Obviously, it is very important that you invest this money wisely because you will be depending on it. I'll help you make the right choice.

Q. I think your correct that it is an immediate income annuity. Here is what it says on the quote. income amt. $364.19 monthly for 20 years guaranteed and as long thereafter as either or both measuring lives shall live.income amts commence on 4/25/2005. taxable portion 172.63 non taxable portion 191.56 I will invest the full 150,000.00 amt. I have set aside funds to have a cash on hand situation after spending 15,000.00 on home repairs paying off a vehicle and buying a used 3,500.00 bass boat. Im sure that will leave enough cash to get by for a year.

I must say that I dont know beans about investing and not to say this as an insult to you. I feel like a housecat in a room full of bulldogs. Thats why I got in touch with you. Your credentials speak for themselves and you are highly respected in the investment area.

A. I've been doing some calculations and you should be able to withdraw $600 per month ($7200 per year) without any problem. Here are some of the numbers.

If we only earn an average of 3%, your money will last 34 years. If we earn an average of 4% you money will last 46 years. If we earn an average of 5% you will not ever run out of money and will be able to increase your income slightly each year. Assuming 5% and withdrawals of $7200 per year (without any increase) your money would still be worth about $170,000 after 30 years.

Realistically, based on the fact that you were considering putting 50% in a growth fund, I believe you could average 6-7% per year if I managed your money using conservative methods that will limit any potential losses to 2-3%. To put that in perspective, the potential losses using a growth fund like you mentioned in the first email could be 20-30-40%. In fact, in 2002 the better growth funds lost over 20%.

I've developed a proprietary money management system that allows you to participate in the growth of the market while rigorously controlling losses. It is designed for those who are more concerned about keeping what they got instead of growing it with a lot of risk.

There aren't any commissions (I get paid by fees), no set-up charges, no surrender penalties and no time committments. If you like, send me your name/address info and I can send you some additional info. I will be happy to help you in any way I can.

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Tax Efficient Investment Options

Q. Husband 53, Wife 48
We own 5 tax deferred accts funded to the max.: 401k, 403b, 2 Roths, 1 Beneficiary IRA. Have 0 debt. Both plan to retire in 4.5 years. Husband only will have modest pension.

I plan to open a taxable acct. I don't foresee needing this money for retirement income. What are my best, tax efficient investment options?

A.Thanks for asking!

First let me say that you have both done a wonderful job and are way ahead of the game!

To answer your Q specifically, I will need to know a little bit more. You mention that you don't anticipate needing this after-tax investment for retirement income--what do you want this money to do for you? Do you want it to grow? Is it money that you don't anticipate ever needing and that will be passed on to children and/or heirs?

Can you tell me a little about how your other funds are invested because it will give me a feel for your risk tolerance.

Do you have a good long-term care insurance policy?

Lastly, are you in a high tax bracket?

There are many options available and this information will help narrow it down considerably. Once you respond I will be able to tell you what they are and give the advantages and disadvantages of each.

Q. Dear Mr. Voudrie,

Thanks for the quick response. To answer your questions:

Yes, I want the after tax investment to grow.
I don't need to, or want to take excessive risk. I can stomach some moderate volatility.

I honestly do'nt know how much I will keep, spend or pass on.
Most tax-deferred accts are mutual funds: Fidelity, Vanguard, American.

My plan now is to hold my bond allocation in tax deferred accts and equity allocation in taxable accts. due to tax advantages,
hense my quest for very tax efficient vehicles.
We have no long term care policies.
Last year we were in 28% tax bracket.
I am an electrician. My wife is a nurse.

Thankyou for your time.

A. C****--let me just say again how great of a job you and your wife are doing financially! You are well on the way to work being optional!

From what you've told me, I would recommend you put the money into some good equity funds. Depending on the amount, you should consider dividing it between multiple. You can use low cost index funds like Vanguard, but if you are investing amounts greater than $1k each time it might be better to consider ETFs. In particular (and depending on the diversification of the rest of your equity positions), I regularly use ETFs with the following symbols: SPY, IWM, IJH, EFA, EEM.

You should also consider using a portion of the after-tax money toward a good long-term care insurance policy. Once retired, the cost of long-term care will be the greatest risk to you and your wife's financial health. I view LTCI as a way of preserving what you've worked so hard to obtain. I think of it as portfolio/wealth protection insurance.

You can find articles on ETFs and LTCI at the website: http://www.guardingyourwealth.com

I hope this helps. Let me know if I can help further.

And feel free to let your friends know they can get free financial advice here as well!

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Graduating with Investments

Q. I’m currently a 21 year old senior at ****. Upon graduation **** offers all graduating seniors a $25,000 loan at a fixed interest rate of 1%. The payback period is 60 months (5 years). We will receive the loan no later than April 28, 2005, and the first payment is not due until December 21, 2005 (8 months after getting the loan). I calculate that starting in December I will owe $427.34 a month for 60 months totaling $25,640.40. There are no stipulations or fine print. My father and I agree that this is free money and I should accept the loan and invest it. I do not need the money for anything, and I also have finances of my own to pay off the loan if a long term investment seems optimal. My question is: What is your suggestion for investment with such a loan?

Very Respectfully,

Edward

A. It really depends on your tolerance for risk. There are some well managed equity mutual funds that you could use that should have a pretty good average over the 5 years. The risk is that there could be a negative return in the short-term. The odds are in your favor, though. There have only been one or two 5 year periods since the 70's in which the market didn't provide a positive return.

A no risk option would be to buy a 5 yr bond or CD. You cold lock in about 4% per year and have no risk whatsoever.

Lastly, you could split the money between the two.

One mutual fund family that has done a good job lately is Hotchkis & Wiley. I don't know if they are a commission-based fund or not because my clients get in without a commission. If you can't find a good non-commission option, let me know and I will try to help you out.

Congratulations on graduation and thank you for your dedication to our country!

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EIA's - Another Example of False Hope?

Q. Jeff, I've been approached by some individuals touting the benefits of Equity Indexed Annuities and they speak solely of a company named *****. They say my money will be safe, there is a minimum return and they did explain a cap with a participation rate of 100%. I'm confused by all this but they said that I would probably average between 6% and 7% without any risk to the money I put in. Is this true? What kind of guarantees would I be able to expect if I were to put my money into a mutual/stock fund or if I had my securities advisor fully diversify my portfolio? Any help would be greatly appreciated.

M.C.


A. Thanks for your question. First, let me applaud you for taking the time to research a suggestion an advisor has made instead of blindly taking their advice!

You mentioned '*****'. In my research I was unable to find an EIA company with that name. I did find one called '*****'. Based on what you said, that may be the one.

Recognize that when they say you should earn 6-7% per year without any risk, that it is completely false. The only 'guarantee' on any EIA is a guaranteed minimum rate. On the ***** EIAs, their guarantee is 3% on 75% of premium. You can see just by how they state this that they aren't interested in making it easy to understand. 3% on 75% of premium means that you are only 'guaranteed' a minimum of 2.25% on the full amount you invest. If you put in $100,000, they will pay you 3% on $75,000, or $2250 in interest.

Why don't they just say they'll pay you 2.25%???

The rest of the 6-7% return they say you should safely earn is entirely based on the stock market. More correctly, you are guaranteed of earning 2.25% IF you leave all of your money in the EIA for 10 years. Any additional earnings are subject to the performance of the stock market.

They aren't even straight with the market-based returns. You either have the option of "yield spread deducted from average monthly positive gains or cap with no spread ". I'm sure you're wondering what that gibberish means...

The Spread Option: The break your contract into monthly periods and calculate the return for each period. That gives you 12 one month returns each year. Then they average them (add them all together and divide by twelve). Lastly, they deduct a 'spread' from that average. I don't know what their spread is and they can probably change it from year to year anyway. But if it were 3%, they would then subtract 3% from the average I just mentioned. Let's say your average was 7%. 7%-3%=4%. So they would credit you 4% for that contract year. SIMPLE ISN'T IT (I'm being sarcastic).

The 100% option: Sure you get 100%, but only up to an amount they decide, say 9%. So if the index goes up 9% you get 9%. If it goes up 23% like in 2003 you still only get 9%.

The bottom line is that you are locked into an EIA and they control everything. They can change how your return is calculated from year to year and you have no recourse.

Tell me a little more about your situation and I will offer some alternatives.


Q. Thank you for your response I appreciate your promptness. I am a bit confused . . . I guess you are right to state that they cannot guarantee 6-7% as the return I might get but because it is going to give me a return based on the S&P 500 what has the average of that been for the last ten or so years? Isn't that what my return would be based on not the minimums? Oh and I found the ***** website at *****.com . . . They have a 100% participation rate, isn't that very good? I was told they also have a 7% cap on the interest rate. That sounds pretty decent in comparison to what I can get on a standard annuity. What do you think?

M.C.

A. I went to the website and couldn't find any detailed information. They didn't have any sort of prospectus--which is common on EIAs. That's part of the reason it is so difficult to evaluate them.

The financial strength of ***** is only OK. An 'A+' rating is nothing to write home about for an insurance company.

The average on the S&P is probably over the 6-7% over a 10 year period. That's another reason against an EIA. You say they have a 100% participation rate but that they also limit the guarantee to 7%. I would imagine they are saying you participate in 100% of the index earnings up to 7%. For instance, in 2003 when the S&P earned 23% you would have only earned 7%. Last year, when the S&P earned over 10% with dividends reinvested, you would have only earned 7%.

You shouldn't compare an EIA to a standard annuity if you are referring to a fixed annuity. A better comparison would be to a variable annuity.

I don't have a horse in this race. I don't have an conflict of interest. I'm not trying to get your account. On the other hand, the person recommending this to you stands to make probably 10% off of you and will provide little or no service after they sign you up.

There are better alternatives without handcuffs.

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