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I can’t stress it enough, with the new year it is time with the stock market being so low (buy low sell high?) that it is time to start buying a Roth IRA.

First pay off any debt you have (other than your house if you have one) but once that is done, it is no better time to be putting money into a Roth IRA. For details see my old post Retirement Planning for Graduates.

So why a Roth IRA? Well if you get a match from your employer plan, you should put money into that every month to get the match. After that use a Roth IRA, you can open a no fee Roth from one of the many discount brokers. Give me an email if you are having trouble I can give you some names.

The biggest reason for the Roth is if you are young, chances are your income is going to go up as you get older. Promotions, starting your thing, etc could push you into higher taxes when you are older. The biggest reason I see right now is all these bailouts? The ones most Americans hate other than all the bozos in DC? They are going to have to be paid some time, and one of the best ways to hedge against paying higher taxes in the future to pay for these bailouts, is to use a Roth IRA, pay taxes now, not latter when they are higher.

So what you should do if you don’t have one already, is set up a Roth IRA and if you can, pay the full amount and be done ($5,000 this year 2009), or have $96 taken out of checking every week automatically. You can talk with your Roth provider how to do this. The stock market is cheap, it is 30% off, it has been flat over the last few months, it could not be a bottom, and I am not one to time the market, but it is obvious, we will look back at this time 5 years from now, and be sad we didn’t buy all the stock we could.

Remember this is just my opinion, understand what you are doing before investing. And I am no way giving advice or binding to any obligation. And please, pay off the damn CC’s, and don’t lease cars. Save and invest.

The current fall in housing prices shows a wonderful example of how the price of something everyone wants, in this case housing, falling can be as painful or more than if prices rise to fast.

There is a conflict at work here. Home owners and near term home owners want prices to rise over time. That is those who currently own homes want to price of their home to look like an investment. This would mean the price of the house someone is willing to pay for it latter is higher above inflation. Not bad, we have heard for years how real estate is a great investment, but what does this mean for everyone else?

Everyone else is low income, or the very young who wont own their home for many years. This is the fight of housing affordability. From a social point of view affordable housing is very important, governments have tried for years to make housing “more affordable”, but do we really want housing to be more affordable? Governments have also done everything they can to encourage home price rising. Be it tax deduction, home owners credit, zoning etc. How many times have you heard of community bi-laws that were to maintain property value?

High property values are in direct conflict with with affordability of housing. People should remember though that a home is a place to live, provide shelter and security, or at worst, store your stuff. Why should our home be investments? Isn’t the investment in having a place for a family an investment in them?

While once I own a house I would love for it to rise in value quickly such that I could sell it in the future to trade for a lake house or other. Problem is if I have children I also want them to afford their own home.

So what will home prices do? I expect home prices over the long term to rise slightly faster than inflation. The rise will be in lock step with the rise in productivity. That is our average wage rises faster than inflation, and we will commit a standard percent of our wage to housing. Other pressure, as building smaller homes being difficult with rising pressure from government for more permits, water hook ups that are over priced etc. That builders can only build larger houses to keep these coasts under control.

In short prices will only be what people will pay for them. Don’t expect to make big money off your home. Unless you can add value to a property (fix it up, develop etc) expect to get what you paid for it after inflation, on average.

I leave you with the plot of house prices as a multiple of income, you tell me what you think house prices are going to be in the future?

For a while I have thought this was a no brainier. Why is it that interest from bonds (ignore those right now) and savings/checking accounts are taxed at full income tax rates? While dividends and capital gains are taxed at a much lower rate?

I have thought for a while that it was dumb to have the lowest earning types of savings (best I have right now is 4%, much less at most banks) to be taxed at the highest rate available. Where do people save first? Their 3-6Month emergency fund! Which should always be liquid in 24 hours in some form of Money Market with FDIC. If you want to know how to find these shoot me a message. The first account parents open for their kids is a savings account. Now while most children don’t have income up to the standard deduction, if they did should a child’s first savings be taxed at income tax rates? In the child’s case yes, because the first tax bracket starts at 10%.

I have been saving cash, mostly because I have kept my living arrangements low key, so while I have a “big boy” job my expenses are still “collage kid”. This cash is to be used for a wedding, a house, decent furniture when I get tired of the stuff I have accumulated (mis-matched couches?). The interest I earn on that is taxed at my full income tax rates. That is the little I get paid on my savings is taxed as though it is income. True I could spend it as income, but people not saving (why save, inflation will kill it anyway?) is part of the reason the sky is falling all over the news. So I always have thought that there should be no taxes on savings (bank savings) to encourage people to have some savings around. Today though I changed my mind, here is why.

I found my self falling into the trap 99% of the public and politicians fall into. That is “let us change this one thing, everything else will stay the same”. This is dumb on my part. The current rates paid on savings includes expected taxes. For example on my best MMA (Money Market Account) I am making 4.00% APR (www.dollarsavingsdirect.com) which because I am right in the middle of the 25% bracket means I am making after taxes 3.00% which after historical expected inflation is -0-. That is right, I find the best I can make to come out even. So I would expect, if taxes were eliminated, over the next few years in the same inflation environment 3.00% on my cash. What this really means is I expect inflation at best.

Point is, because tweaking some law looks like a good idea, for those like me who save because they should and is the right thing to do right now. Not all things will be equal. To assume nothing else will change. “4% is great if I didn’t have to send 25% of it to congress to waste”, won’t work out that way. The same will apply to bond rates. Now maybe you would want to effeminate taxes because these rates are baked into everything that borrows money. Car loans have higher rates because the person buying the bond (loaning you the money) has to pay taxes and will only take that bond if they can make their taxes. Same goes for school loans, house loans etc. So maybe again eliminating taxes on interest isn’t a bad idea. Oh wait, but if you do that, then why take the risk in stocks? If your just going to pay some of that in taxes, the stocks minus bonds rate will be smaller, net of taxes. So now people are all buying bonds and not providing companies with capital they need to make jobs.

The next time someone says they have all the reasons why changing taxes will be great, punch them (including me, because I still hate our tax system), because they have no idea what all the other 300+ Million Americans are going to do to compensate for that.

Note I mention a car loan above, I in no way encourage anyone to ever take a loan or lease a car. I think mathematically it is a good way to keep your self from getting ahead. When an auto company is making more on leases than the product, be worried.

Some thoughts on government intervention that I am sure most people at face value would say is great really distributes wealth from the lower and lower middle classes to the upper middle and high class.

It was all done with Hybrid cars. Turns out our all wise government decided we need to have tax credits when buying a new hybrid car (Reference). At face value sounds great, this will encourage production of hybrids because it will lower the cost to get a hybrid thus increasing the number of people who can afford them. It gets support from green/auto/union etc.

What is the side effect of this policy though? Turns out in absolute terms it’s not all great. Hybrids being new and complicated are kinda pricey. Cheapest base model I found was around$20,000 (2008 Toyta). This is out the range of price for a regular house hold. Remember the median house hold income is around $47,000/yr and that’s on average a family including kids. So the only people who can really afford these cars are upper middle class and wealthy people.

So this is where the short change comes in. Only wealthy people can afford these cars and thus they get the tax break. Everyone pays taxes though. So everyone pays in to provide these breaks but only those who are rich can get them.

Now there is some technical arguments against this, mostly based that we run a deficit and thus the whole does not make up for these credits, its just financed. In general thought though when was the last time you saw someone say we could raise the taxes on the rich (roll back the Bush tax cuts) also say and get rid of that tax breaks on hybrids. I best most who want to do the first would not want to do the second. In the end it’s all money.

Just trying to keep people honest. If anyone can think of a reason why we should do such things please try to convince me.

Ok random thought time. What do we spend 1/3rd our life doing? We engage in an economy. We work, we buy, we sell. When I sit back and think about it of the time we spend living engaging in some for of the national economy is quite large. I also think its the one thats most fragmented. I don’t think people think about the connection between work, buying, and freedom.

In the last 50 years or so the government has had more and more control over our lives by getting involved with the economy. Organizations like Fannie Mae and the FDA in their own way intended to help us have caused problems all their own. I am now going to regurgitate thoughts onto paper so hang on.

How does Fannie Mae help us? How does Fannie Mae hurt us? While I think Fannie helps some with keeping the cost of owning a home lower (see my older post, about how I don’t know if this is a good thing or not). The problem it can cause is worse than the benefit. Many of these organizations are put in place as though they can never fail. Problem is anything built by man can fail and does given the right means. Problem is when a government entity fails it can threaten to really hurt a market. Notice I don’t say take down. You can every kill a market, as long as there is two free people each with something the other wants the market will work. Its more a question how well it would work.

Take large banks. Right now we see many of them having trouble because they got over their head with sub prime loans, just like Fannie Mae did in the name of ‘promoting home ownership’. Not all the banks did though. There are many banks, many very large when one of them fails it hurts. It is not possible for all banks to fail, there is just to many. So even in the worst kind of misbehavior the damage is limited. Now lets look at similar government organizations. While Fannie Mae and Freddie Mac both service the same purpose they are only two institutions and its much simpler for 2 to screw up and fail than many. Its just the statistics of it. We now find our self’s where the government has to bail them out at a huge cost. The bottom and consequences because Fannie Mae exists is worse than if they were never created in the first place. Without them blood would have been split, oh the initial shock might have been greater but how far the market could fall should government not do anything would be much less.

Because government got involved in the private property business, that is encouraging the owner ship of one type of propery (real estate). The problem can and are worse. Then the amazing thing happens that only happens in government which I will go on to explain next.

All institutions have intentions and results. The hard part is getting from the first (intention) to the second (results) and having them be equal. In the market if you get to far from results equaling intention you go under. People loose there jobs (that’s great) and the organizations that do make it from intention to results grow. Those who worked at the now failed organization are freed to work in more effeicnt and successful organizations. That is the market is self correcting though it is not kind. In the end we are all better off.

Government instutions also have intentions and results. The change here is that when the results don’t land near intentions instead of failing more often money and resources and authority (new power invoked by congress) in added making the failed beast even bigger. This is what amazes me. Fannie Mae screwed up, is put its fingers into the wrong pot and got bit, in a working market they would be eaten up by those more prudent and better heads would lead from then on. Instead the same people will be taking money from tax payers (who are now bearing the risk of a publicly traded company no the share holders). To keep them up and even lax the rules on what Fannie is allowed to buy! Does this make any sense?

Fannie is just one example, there are many more, find one time where a government organization has failed and the leading body, be it congress or local board, say “shut it down, it failed”. No we keep trying with the same broken POS.! Tear it down, maybe try something radically new but judge them on their results and admit failure. I think history shows more often failure by such organizations than success.

In the end, again I feel my brain pushing me more and more towards Ben Franklyn style thinking. It is true I think, that the Libertarians are the closest thing we have to our founding fathers. If I was ever asked if I would rather be a man like the founding fathers or the current crop of leaders, my answer would be quick and simple.

End Rant.

You may think I am going to talk about welfare, well I am and I am not. I am going to talk about welfare for the middle/Upper classes.

Recent episodes of Econ Talk have made me think harder about some of the things the government does.

The Federal Government subsidizes people who own homes. Yes people who own homes. It is called the intrest deduction. The Federal Government allows those who itemize to deduct any interest paid on their mortgage.

For many this reduces their taxable income by $10,000 or more a year. My problem is not that there is a deduction (I like the flat tax, or negative income tax). I can’t for the life of me figure out why you would really want to promote home ownership? Really what does it provide? There is the usual argument that people care for it better etc. I don’t think this is it. I think the benefit goes to the state. If this is the case just give some fraction of income taxes to the states!

Here is why I think that. I think people think very differently about renting vs. owning. While currently I am willing to rent a small two bedroom apartment and keep a roommate. I am not willing to buy a similar kind of property. What this does is cause a demand for more high quality housing (no one wants to buy rent quality housing). Because there is more high quality housing property taxes are higher per-capita than in a case where there is not a deduction (incentive to own) on your house.

While I think that is the case I do not think that is the case. Because the deduction on mortgage interest has been around for so long people expect it. I doubt many would have bought as an expensive house if they didn’t expect to get 1/3rd of their interest back from the government. Thus while it might have helped some when first put in place because the prices of real estate would not have adjusted quickly. By now I am sure the benefit of the deduction is baked into prices of all houses now. I don’t think many could even afford their homes without the deduction. I am almost certain though that if there was no deduction that exact same house’s price would have been lower by around the amount of the deduction.

So why do these prices rise to match all added benefits to go along with it. Well the first rule I think to prices adjusting to match something like the deduction is that it must be long term. Prices must be allowed enough time to float to absorb the benefit. Thus a coupon would not have the same affect on prices. A good example is Art Van. Here in Michigan Art Van is always advertising a sale huge amounts off sticker. I have come to think that the sale price is the sticker price and that the “sticker price” is just some made up number. The rest is marketing. On the other hand when another store has its once a year sale I see value in the sale, Not so much for Art Van and its sales 100% of the time.

We are simple animals and like a deal, but we all fall victim to the what have you done for me today. Because the deduction has been around for so long we don’t care any more. Its just extra hoops we will jump into because we have to because the price of houses require it.

The biggest point I hope anyone who reads this (if you do please comment) is that the market will adjust to give housing of X type to someone who produces Y output. The price of the house X will adjust to equal some % of the workers time who has output Y. Thus is the market says programmers should be above average earnings they should have above average housing and the price will reflect all deductions and market realities. People will trade some amount of their Time (read output from work) for housing. And that time will be replaced with a house that takes a builders time, and a loggers time etc. The addition of the deduction does not help in any persons ability to acquire it in the long run. The price of the house will go up (from its deduction free price) to match the deduction. In the end the programmer gets the house a programmer is willing to trade his output for.

I think this idea of we trade time and effort for the output of others (they trade for our output time and effort) and that we always come out to equilibrium is what a large number of people don’t understand. And that any addition/subtraction from the cost will just be subtracted/added back in over time. So that the amount of output is equal.

I will close, I really hate inflation, fed go jump in a creak.

I have a problem. When I entered the work force it was pointed out to me that after I leave I will live another 30-50 years.  During this time I will not have a income Social Security is a mess that should never have existed so I needed to do some retirement planning. What I found was that its very easy for the middle class 20 something to save for a comfortable retirement without government help as most people think.

Now many of my friends who went on to grad school and are now getting jobs have been asking me what they should be doing I figured I would write some posts.  Note I am not a CPA be sure you understand any product before you buy it.

1. How much to save?

You should save at-least 15% of your pre-tax income.  This number can include employer matching in a 401(k) or 403(b) but if you go for 20% you can be much safer.

2. Roth or traditional IRA? Roth or traditional 401(k)? 403(b)? 457(b)?  Where should I put this money?

First Never touch money for retirement unless you have to. Getting a new car is not a have to and nether is collage for your children (I will cover this later). Some of the accounts (401(k,b)) let you take loans, don’t do it. First If your employer provides matching funds on your money contribute enough to get all the match.  That is if they have 50 cents on the dollar for the first 6% put in the entire 6%.  Its free money don’t ever pass it up.  If the employer provides a Roth 401(k) or 403(b) use the Roth option over the traditional (I will cover why latter).

Once you have maxed out the match open a Roth IRA at a company like Fidelity or Vanguard (I use Vanguard). Once you have hit the limit for the Roth IRA any extra money you need to save should go into your 401(k) or 403(b) until you get to at least your 15% total in.

3. There is so many options to put my money in and I really don’t know what ones to put my money in!

Use a target date fund. These funds are a collection of mutual funds that have a target date on which you will begin to draw money.  The farther out the date the more stocks and aggressive they are.  These funds provided by most major mutual fund companies take out the guess work that used to be provided my your employer.  So if you don’t want to learn where you should put your money let experts do it for you. I personally use Vanguard target date 2050 (VFIFX) for my Roth IRA. 

4. What should I not use for retirement? 

Don’t use the following in a tax advantaged account. All IRA’s and 401(k)’s 403(b)’s and 457’s are tax advantaged accounts.

• Annuities
• Variable Annuities
• Whole Life (Cash Value) Life Insurance
• Hedge Funds
• Any fund that has expenses over 1%
• Loaded Funds

Really avoid Variable Annuities they provide no advantage for long timer periods and are very expensive. Don’t be taken in about principle protection or death benefits. If you want to know why email me at brockp@mlds-networks.com

Stick to low cost mutual funds like those from Fidelity, Vanguard, Tiaa-Cref or T-Rowe Price.

Please put any questions in the comments. Do not use any numbers if you want some help going over some options talk to a planner or you can email me at: brockp@mlds-networks.com 

Thats really all you need to know, I have some other information below like:

• Why Roth over traditional for young people?
• How to make your own pension plan.
• What is a 401(k) 403(b) and 457?
• Why to save for retirement before your children’s collage

1. Why a Roth over traditional for young people?

First a Roth plan (401(k) or IRA) is after tax. The money you use to pay in you have already paid income tax on it will grow with no taxes on it and when you withdraw you pay zero taxes. A traditional IRA you pay no taxes putting the money in grows without paying any taxes but any money you withdraw in retirement you pay income tax on. 

Young people in their 20’s are just starting the workforce there will be promotions and bounus in the future and our tax rate will climb. So while we are making the least we ever will pay the taxes now in your lowest tax rate and get the money tax free when you retire in a higher tax bracket.  You can also look at political topics where the answer is cut benefits to medicare SS and others but the feel good way is to raise taxes.  We are also in a low tax environment post Regan.

Now for our parents who are in their peek earning years maybe want to avoid taxes now and pay them latter when they have a lower income in retirement.  It all depends but in most cases the numbers point to if your young use a Roth. 

2. How to make your own pension plan.

Upon retirement buy Immediate Annuities. Annuities? Didn’t I just say don’t put money in Annuities. Yes I did and if you do you will be sorry.  Annuities are awful to accumulate money in but great for keeping your income stable.  An Annuity is a contract where you pay a insurance company some amount of money and they will send you a check for the rest of your life.  Don’t worry about this at this point in your life right now you need to accumulate as many assets as you can to take care of your life and family when you stop working.

3. What is a 401(k) 403(b) and 457?

401(k) and 403(b)’s are the same thing. The only change is that 403(b) worker are non-profit and government employed. 401(k)’s are for profit organizations.  A 457 is treated the same tax wise as the 403 and 401 but has slight changes.

These traditional plans are pre-tax. Money goes in without income taxes being paid. Grows tax free but you have to pay income tax when you withdraw money.  Roth versions of these plans are after tax and you never pay taxes again just like the Roth IRA. Note that even with the Roth version employer matches are pretax and will still have to pay income tax on these contributions when you withdraw. Your own personal contributions you will not pay taxes.

A 457 only changes when you can withdraw the money. You can access 457 money when you leave that employer. The 401k and 403b require that you have of a age before you can access the funds this is not true for the 457.  457’s are great for those who are on track to retire before the age limits of the other plans or who have maxed out the limits of the others.

4. Why save for retirement before collage.  

While I know you all want to save for your kids school they can get loans and have their entire working life ahead of them. There are no loans for retirement and unless you want to be living with your children you better take care of your self before you do their collage fund.

When you do have funds for collage be sure to use a 529 plan. Right now its the best way to save for collage. And this like retirement the sooner you do it the simpler it is to do. 

I know I promised some of you information on another topic but that will have to wait for now.

My grandmother has some extra savings as any American should and given her age and risk appetite she invests (more like stores) this money in CD’s (Certificates of Deposit). Now banks just as with savings accounts offer differing rates of return with different maturity rates. Up until recently she has these CD’s at Fifth Third Bank (www.53.com), they had competitive rates they were local and given that grandma likes to have a face to speak to she kept her money there.

Now recently Fifth Third’s rates have fallen from being competitive. So grandma asked that we look around for other rates to find something that maybe would keep pace with inflation. Now I have deposited some money personally at Countrywide Bank that I am saving for a house down payment. Countrywide isn’t in the best position in the market right now and is paying wonderful rates on their CD’s to attract new money.

Yes there is a chance Countrywide Mortgage might declare bankruptcy. I don’t think their banking operations will and in any case the accounts and CD’s are FDIC (www.fdic.gov) insured. This where the dishonesty started.

I receive a call from my mother who went in with my grandmother to cash our these CD’s. When asked what they were going to do with the money, under no obligation to answer, they told them they were buying a CD at country wide. The lady was not happy and pointed out Countrywide Mortgage’s current troubles. When my mother replied well its FDIC insured and we doubt that someone would not buy them out we were at no loss of value and over double the rate offered by Fifth Third. The woman that goes on to claim the following:

• FDIC is a corporation and not a government office
• FDIC pays $0.07 on the dollar

Now both these statements are false, some more than others. The first point, FDIC is a Government sponsored corporation. "FDIC insurance is backed by the full faith and credit of the United States government"¹. So true its a corporation but is backed by the Governments ability to print more money and collect taxes.

Second, FDIC pays you 1:1 up to the insured limit². The statement about $0.07 was a scare tactic used on a old woman and I am pissed. I will not allow anyone to pull a fast one like that on my grandma. All I can say is I will not use Fifth Third for any type of banking for the forseable future.

This was down right dirty.

For those of you I do not encourage the use of CD’s for growing money. It is only short term cash. It is better to pay down your house/car/credit card before storing much more than emergency money in a savings account. If you have money to grow for more than 7-10 years you need to get into stocks and bonds, and a argument could be made to only stocks for growing money after inflation.

Oh and Jori, yes stocks traded in Euros go up in value when the dollar drops. So you can use stocks (Diversification) to fight against loss of value of the dollar.

I was going through some mail some of which was for my Roth IRA. Now I was very fortunate my parents encouraged me to start a IRA while I was young and I am very much better for it. What my parents didn’t know was that they were being sold crap and the worse case I am stuck with crap.

Now I wont go into what a Roth IRA is, but what my IRA ended up in is a Variable Annuity (VA). Now a VA has some nice features, like tax deferred growth but hey a Roth IRA CAN NOT be used for this purpose so that benefit is lost but the cost of it is still there. In the end my mail pointed out the following: the cost for the underlying funds were all at least %1, BUT thats not all the annuity charge was over %1.6 for a total of %2.6. Do I see any benefit from the things the annuity offers? No I do not, I am only 23 why do I need principle protection? Or death benefit protection? I have no one to take care of if I die, and because its a Roth IRA I have 37 years before I withdraw the money so why bother with ‘principle protection’ ill be up way over my principle anyway!

I have a few other beefs with Hartford:

• Their web-site only uses SSN numbers for logins
• They don’t use consistent names on the documents they send you vs online. The fund you own on the website might use a different name than the Q1 report.
• The funds drift! One of my funds turned from value to growth!
• Deferred sales charges!

I did some looking into this and I decided to put my money for this year in Vanguard 2050 fund. The total costs for this fund is 0.2%. A full 13x’s cheaper to own for the same expected growth. Oh and if I decide to move my money to another company I can do a rollover and no fee kicking you in the pants when you leave. So how I see it everything a person my age needs for a Roth IRA without the downsides. My only worry is how many people are getting screwed by salesmen selling VA’s because VA and whole life policies pay the largest commission to the seller.

Here is a example, it assumes $100,000 invested and that all funds return 10% annual before expenses. Note I believe in the Efficient Market Hypothesis so all these funds over the long term should show the returns of the market. I run over to the nice calculator at Dinky Town and in 37 years find:

So that somewhat small difference in price resulted in almost $2 million in lost return.  All that money (that should be your money) went to someone else. So Hartford I will never recommend you to anyone for your bad website, your bad (but common) fees.

After this rant you might wonder why I still leave my money there, well the reason is the deferred sales charge, my parents rolled over my IRA and I went along with it, well Hartford (and most VA turns out) will charge you 8% of your money if you withdraw before it has sat for a few years. This amount goes down a little every year. So I do plan to move the money out when it hits 4% charge.

Last Bank of America whats the point of raising the rate on my CC I have with you that i never use? How is that going to get me to use it? More and more I think I should live a cash only life. Debit card for buying things online. I would love to hear what all of you think about this or the above rant, please comment below or email me directly.