Taking Responsibility for Retirement: How Today's Scary Headlines Can Help Your Retirement Plan

First, it was the combined whammy of the tech wreck and the post-9/11 recession that battered our 401(k) accounts. Next was inflation in health care and education costs that further diverted indebted consumers from concentrating on retirement. Now come the headlines that any company facing tough times – or intense shareholder pressure – can pull the rug out from under its retirees hoping for the traditional three-legged stool of retirement – pension, Social Security and savings.

 

All three legs are in trouble – we aren’t saving enough, Social Security is under attack and traditional pensions are disappearing – fast.

 

For retirees facing a sudden loss of pensions and benefits, there are really very few options save going back to work or turning home equity into a personal bank. So the time to start taking on the lion’s share of your retirement responsibility is now, whether you’re five, 10, or 20 years away from hanging it up, if that’s your plan.

 

One general tip. If you’re not really certain where you stand, get some help. If you’ve never sat down with a financial adviser it may be time to get a second opinion on your retirement readiness. The meeting may yield some ugly news, but it’s better to know the options than cross your fingers.

 

Here are some things you may want to discuss:

 

What does ‘retirement’ mean to you? It’s arguable that traditional retirement is going to be dead for many of us. So you may want to start thinking about a second part-time career or new ways to earn.

 

Think about an annuity: Annuities are investments that provide fixed or variable payments to the investor over a set period of time. The collapse of traditional plans is putting new focus on the annuity business, and it’s worth talking about with an expert.

 

Do a retirement spending dress rehearsal: In the last few years before retirement, see how much you can live like you’re already retired. Give up the lattes and the pricey clothes and dinners; see if you can live with a smaller car or a used one. Retirement is easier if you can downshift into it, both from a monetary and activity standpoint.

 

Get in shape -- physically: It may be strange to hear health advice tied to your financial wellbeing, but it should be one of the first things you consider. That’s because the numbers on a bathroom scale, blood pressure monitor or cholesterol report can dramatically affect the cost of your healthcare and insurance premiums going into retirement. You’ll find that pre-existing conditions can boost your premiums – or possibly deny you coverage. That’s a very ugly surprise going into the years when you’re going to need healthcare coverage the most.

 

Consider a career shift: It may be a bit extreme to switch careers just because a particular employer has better benefits and savings options. But if the job appeals to you and you can make a move without endangering what you’ve already accrued, why not consider it?

 

Use your catch-up options: Various IRA and 401(k) options allow you to make additional contributions over standard savings limits above the age of 50. Make sure you know what those additional amounts are and take full advantage of them.

 

Don an investment inventory: In a 30-to-40-year career, an individual may have gathered bits and pieces of pension benefits and personal savings and investments along the way. Likewise, there might be insurance policies, savings bonds and other small investments that may have slipped one’s attention. A re-evaluation of retirement options should begin with a full accounting and reorganizing of all investment and savings assets, preferably in an organized outline that’s easy for you and your adviser to access.

 

Think about health savings accounts: Today, there are strict limits and spending rules for health savings accounts, but if some lobbyists get their way, there might be a day when health savings accounts can become a long-term savings solution similar to a 401(k) plan. Getting into the pre-tax savings habit with health care dollars is a good habit to get into in case there’s more flexibility awarded to these accounts in the future.

 

June 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

Getting Started with ETFs

Conceived more than 80 years ago and now owned by 91 million individuals from 54 million households in the U.S., mutual funds owe their strong appeal to a combination of features: professional management, instant diversification for low minimum investments, prices based on net asset value (NAV) and marked to market daily, and easy reinvestment of dividends and capital gains.

 

Known legally as open-end investment companies, they issue new shares when investors want to buy them at NAV per share—plus sales charges unless they are no-load funds—but they must redeem shares at NAV (less sales charges unless they are no-load funds) when holders want to sell.

 

These characteristics have long distinguished mutual funds from a second type of investment company, closed-end funds, whose issued shares are fixed at creation. This means that bid-and-ask prices may be above or below NAVs.

 

The third type of investment company are Unit Investment Trusts, which are a fixed basket of stocks (not an evolving index) held for a pre-determined time.

 

If mutual funds have been found by some to be lacking a feature, it often has been the opportunity to buy or sell their shares at any time when markets are open at known prices—just like publicly traded stocks, bonds, and closed-end investment companies.

 

Exchange-traded “equity” funds (ETFs) were introduced in 1993 by a subsidiary of the American Stock Exchange. They are designed to give investors a vehicle that resembles mutual funds but also provides the opportunity to have buy or sell orders promptly executed at known prices on a securities exchange (through a broker) whenever markets are open.

 

Named the SPDR Trust, whose shares were referred to as “Spider  (for SPDR, or Standard & Poor’s Depositary Receipt), the first ETF was formed as a UIT with the investment objective of tracking the S&P 500 Index, thereby permitting its portfolio to be changed when S&P changed the composition of its index.

 

Its investment policies thus were similar to those of the mutual funds that had been passively managed to match the performance of the S&P 500, beginning with Vanguard 500 in 1976, or other domestic and foreign stock and bond price indices.

 

Over the next three years, three more ETFs, organized as UITs, followed the SPDR model, matching the following underlying stock indices, the S&P MidCap 400, the Dow Jones Industrial Average, and the NASDAQ 100. By 1996, a major change occurred when the first two ETFs organized as open-end investment companies were introduced.

 

ETFs have experienced phenomenal growth. By the end of 2005, ETF total assets had reached $296 billion. Some193 ETFs were organized as open-end funds, representing 68 percent of total ETF assets and eight were organized as UITs, representing 32 percent. At the time, as much as 63 percent of ETF assets were broadly diversified across domestic equity sectors while 10 percent were concentrated in individual market sectors or industries. Another 22 percent of ETF assets were invested internationally; the remaining 5 percent, in bonds.

 

Why have ETFs been so successful in attracting investors?

 

1. Whatever their investment characteristics, the offer of professionally managed portfolios resembles mutual funds—whether invested in diversified or concentrated pools of domestic or foreign stocks and bonds.

 

2. The cost of ETFs is much-debated, but many financial planners tend to agree these vehicles can be cost-effective when used correctly. For instance, shares of ETFs structured like index funds may have even lower annual expenses than index mutual funds, which, in turn, tend to be lower than those of actively managed, low-cost mutual funds. ETFs must, however, be bought and sold through brokers and those trades do involve sales commissions. Of note, some financial planners say ETFs tend to be good vehicle to use when a large amount of new cash comes into an account. But, due to commission charges, ETFs are not recommended for people with small accounts or those that are dollar cost averaging.

 

3. ETFs are transparent investments. Unlike traditional mutual funds, ETF holdings are fully transparent. Investors know what holdings are in the ETF at any given time. Each ETF also has a NAV tracking symbol for even more precise analysis. This helps keep ETFs trading within pennies of their intra-day NAV.

 

4. Taxes may be managed. While well-managed index mutual funds may distribute less in taxable capital gains than actively managed funds, the SEC’s 2001 release noted that “the ETF structure may allow an ETF to avoid capital gains to an even greater extent…”

 

“This is a really big deal for taxable accounts – it is almost an unfair competitive advantage for ETFs,” said one financial planner member of the Financial Planning Association.

 

Many ETFs have not distributed any long- or short-term capital gains in five years or more and if they have, the distributions are very tiny. Financial planners also note that because ETFs trade like stocks, an investor is able to control the tax treatment of an investment. By holding an ETF for at least one year and a day, capital gains will be treated as long-term capital gains which are currently taxed at 15 percent (10 percent for low tax bracket investors.) 

 

6. Trading flexibility—the ability to buy and sell ETF shares any time during the trading day and at a known price—that index mutual funds cannot provide. Unlike mutual funds, ETFs can be bought on margin or sold short, the normal up-tick rule when shorting ETFs is not applicable.

 

June 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

ABOUT THAT DREAM VACATION HOME.

With observance of Memorial Day behind us and vacation season at hand, it’s time in many American households for two perennial questions:

 

·         “Where shall we go this year?”

·         “Should we pay rent in a hotel or resort again, or does it make more sense to apply the money toward getting a place of our own, which we will then have whenever we want to go there in the future?”

 

Many households answered the second question with a “yes” last year, and others are expected to do so again this year.

           

Vacation homes—of which the U.S. Census Bureau identified 6.8 million at last count—accounted for 12.2 percent of all homes purchased in 2005, and, at a record 1.02 million, such purchases were up 16.9 percent from 872,000 in 2004, a recent survey by the National Association of Realtors reported.

 

Their median price—whether detached single-family homes, cabins or cottages, or multi-unit buildings—was $204,100, up 7.4 percent from 2004’s $190,000. Their median size: 1,480 square feet.

           

Vacation homes’ share of 2005 purchases lagged the 27.7 percent of homes which were bought for investment—whether to generate rental income, diversify assets, or both.

           

To David Lereah, NAR’s chief economist, it was not surprising that the two categories of second homes combined would constitute almost 40 percent of residential sales, up from 2004’s 36 percent. (Although commonly used, the term “second” home is a bit deceptive: about 6 of 10 second home owners surveyed by NAR were found to own two or more homes—for vacation and/or investment—beyond their primary residences.)

           

“The baby boom generation is driving second-home sales,” Lereah said in a statement. “They’re at the optimum point in life when people become interested in second homes. They’re at the peak of their earnings (and) interest rates remain historically low.”

 

Economic conditions remain relatively strong despite inflationary pressures due mostly to rising commodity prices and lower consumer spending. The resulting higher interest rates have lead Lereah to expect a decline in purchases of investment homes this year. “There are fewer incentives to speculate in the market with price appreciation cooling in much of the country,” he adds.

 

“Vacation home sales will remain strong for the foreseeable future, given the fact that baby boomers are favorably positioned in terms of affordability, as well as being at the stage in life when people are most interested in making that kind of a lifestyle purchase.”

 

That, to be sure, is not to suggest that the vacation home market is going to be as firm everywhere in 2006 as in 2005. As Barron’s concluded in its May 29 issue following a survey of the broad second-home market across the country: “After a long string of double-digit annual price increases, a number of second-home Meccas across the country are suddenly suffering from plunging sales volume and burgeoning inventories of unsold homes.”

 

Though the official figures on sales prices have yet to reflect the current round of cuts, interviews with real estate pros and others strongly suggest that the averages are deteriorating in a number of key markets.

 

An April 14 overview of coastal resorts by its sibling, The Wall Street Journal, reported not only price cuts (“offers that would have been an insult a year ago are now being accepted,” according to a Cape

 

Cod real estate broker), but also other steps to promote sales: cuts in brokers’ commissions, increases in housing ads large enough to inflate a newspaper’s size, and supplemental devices such as listings under glass tabletops at an ice cream parlor.

 

Despite the weaker prospects for 2006, the longer-run trends underlying the vacation home market are expected to remain on track, mostly due to the aging of the baby boomers.

 

“Vacation home buyers are making lifestyle choices and purchasing primarily for their own enjoyment,” Lereah emphasized, citing NAR’s 2005 survey findings for illustration: 72% percent of owners said they planned to use the houses for vacations and family retreats. Moreover, 18 percent expected their vacation homes to become their primary residences in retirement.

 

Economic motives seem to have played a minor role. While one-third bought to achieve greater diversification of their assets—well below the one-half of investment home owners who had that motive—only 13 percent bought to earn rental income vs. two-thirds of investment home owners. (Of vacation homes which their owners rent out, the median number of nights rented is only 12 per year, far fewer than the number of nights that owners of investment homes rent out theirs.)

 

The typical vacation home owner participating in the NAR survey was 59 and earned $120,600 last year. As many as one-third had paid cash, commonly out of savings or from proceeds of real estate sales, and of those who got mortgages, the median down payment was 27 percent. Of the total universe, 82 percent owned their vacation homes free and clear.

 

The median distance between a vacation home and the owner’s primary residence was 220 miles; 34 percent bought within 100 miles of their primary residences, and, ironically, another 34 percent bought 500 or more miles away, enough to get them to an ocean, river, or lake (66 percent of preferences), recreation or sporting activities (39 percent), vacation or resort areas (38 percent), and mountains or other natural attractions (31 percent).

 

Among the leisure activities of interest, beach, lake or water sports led the list at 57 percent of owners. Boating was next at 38 percent, followed by hunting or fishing (32 percent).

 

Of course, it’s imperative that those evaluating whether to buy or rent a vacation home should crunch the numbers. Most financial planners would recommend a thorough quantitative analysis showing the cost/benefit of buying or renting a vacation home.

 

June 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.