Wednesday, October 14, 2009

More Money Less Angst: Don't Max Out Your 401(k)

Latest information from Bridget Sullivan Mermel - one of our favorite financial planners. Get on her mailing list if you can. You won't regret it!

If you were to get on the Internet and poll the financial gurus, the message you would get load and clear is: Save Money. No matter how much you've saved, you will be woefully short when you get to retirement.

The first suggestion of these pundits? Put money in your 401(k). (I will use "401(k) as a surrogate for all retirement savings plans: 401(k), 403(b), SEP, SIMPLE etc.) I'm not against 401(k)s. Actually, I'm a big fan. However, I think the advice is wrong.

Here's my message: Save 10% of your income. Put your money in a savings account. This will become your emergency fund. Accumulate 10% of your annual income in your emergency fund if you've got a regular job. 20% if you worry you're on the brink of losing your job or are self-employed.

For the first 6 months or so, this amount might seem measly and the whole project might seem like it's not worth it. You can supplement your saving by putting in money from any cash gifts, tax refunds, or other windfalls. Don't put 100% of the unexpected money in your saving. Put 33% to your savings, 33% toward your credit cards or other debt, and 33% go out and spend. If you don't have any debt, the proportion is 50/50.

Once you're got a fully funded emergency fund, start saving in your 401(k). But even then, don't max out your 401(k). Find out what your company match is. (Your company match is how much your company puts into your 401(k) for every dollar you do.) Instead of putting the 10% of your saving into your emergency fund, contribute to your 401(k) up to the company match. If your company doesn't have a match, start putting 3% into your 401(k). With the other 7% of the earnings you are setting aside, start saving for a house.

Don't max out your 401(k) until:

  • You have an emergency fund
  • You have paid off your credit cards
  • You have bought a house or condo (or know that you either have enough saved for a down payment, or that you will never buy a house.)
That means that if you are maxing out your 401(k) now and don't have an emergency fund, stop maxing out your 401(k). Does this sound like heresy? I'll say it again. STOP.

I recommend this because the number one thing you can do lower your financial angst is to have an adequate emergency fund. Grow up and stop living paycheck to paycheck. Adding to your 401(k) won't lessen your current angst, establishing an emergency fund will.

What if you try this and, after a year, you haven't accumulated any savings? In other words, what if you're incapable of leaving the money alone? Cut up your credit cards. Start paying for everything with cash. A colleague of mine, Ken Robinson, has a terrific book that just came out about how to start saving. It's called Don't Make a Budget. If you can't figure out how to save, or if you try and you just can't do it, get his book.

Sometimes people object to this advice. But Bridget, they say, money in a savings account isn't doing anything. It's just sitting there.

I tell them, instead of thinking your money is just sitting there, think it's meditating. Your money is meditating so you can relax.

Besides, these days, with the Internet, there are high-interest savings accounts. I like INGDirect, and a lot of advisors I know recommend Emigrant Direct.

These are online savings accounts that make it easy to transfer money from your checking account, are insured up to $250,000 per account by the FDIC, and offer a higher interest rate as part of their marketing strategy. The two banks I mentioned have offered high rates for more than 5 years, so I don't believe their interest rates are one-time teasers.

What's the difference? ING Direct is paying 1.3 percent now. I saw a recent Fidelity statement showing a money account earning .07 percent. Chase currently pays .01 percent for the standard savings account. That means that if you have $10,000 in your savings account, you'd make $130 a year at ING Direct, $7 at Fidelity, and $1 at Chase. At Chase, you could argue your money wouldn't be doing much.

But one thing you know for sure is that it won't be going down. There's some charm in that. People who have lost money in the stock market plunge can see a lot of charm in that.

****************************************************

New on Bridget's website: www.sullivanmermel.com
The latest Financial Focus including the following articles:

A Lost Decade?
Read Any Good Ones Lately?
Holidays and Gifts
Saving Our Economy the Old-Fashioned Way

Any Good Ones Lately, by Linda Leitz, is a review of personal finance books. This article struck me; I've read all of the books on her list and agree 100% with her assessments.

************************************************

Shameless self-promotion
I've been invited to contribute articles to the FI Guide, which is a blog of fee-only financial planners. My recent article "Is Now the Time to Get Into Real Estate?" is their number one viewed article. Check it out!

This information was provided by: Sullivan Mermel, Inc., 3744 N. Southport Ave., Chicago, IL 60613

Labels: , ,

posted by The Office Grapevine at 12:23 PM 0 comments

Wednesday, December 10, 2008

How Bad Can It Get?

This is reprinted with permission from Bridget Sullivan Mermel. This really helps us to keep perspective on the current economic times.

So I revisited an article that Bert Whitehead published recently. Originally written in 2001 after 9/11, the article addresses the often unacknowledged fears that the country as a whole is experiencing. Yes, even the upbeat folks like me and my clients share the fears. Bert has been in the business since the 1970s, and his home base is outside of Detroit, which I think both contribute to his broad perspective. So, after I reread his recent article, I decided to scrap what I planned, and send along what Bert has to say in full.

It's time to get our heads out from under the covers and face our worst fears. The financial crisis is world-wide, and the U.S. is actually better off than most countries. Iceland is bankrupt, and others (including Russia) are teetering. What happens when a crisis turns into a complete collapse?

Keep in mind that the worst possible outcomes are short-term. We'll take a look at those and
then look at the reality of the long-term.

Short-term Possibilities:

Scenario #1: Complete Financial Collapse.
Likelihood = 1% - 2%.

This could rival the Great Depression scenes we see in old movies with bread lines, tent towns of
homeless, etc. You're not able to use your credit cards, or write checks. In the worst case, where
faith in US dollar evaporates, bartering or using gold becomes the basis of commerce.

This extreme outcome could be produced in our current economy if one or two extremely destructive exogenous events occur in the next year or so. These traumatic events could be anything from a huge California earthquake, Al Qaeda usurping power in Saudi Arabia and
strangling the world's oil supply, or severe weather changes brought on by global warming, etc.

We have suggested that clients who are genuinely concerned about this worst-case scenario keep 1-2% of their portfolio in gold bullion.

Scenario #2: World-wide Deflation.
Likelihood = 5-20%.

Countries try to protect their economies using tariffs, which sets off retaliation in other
countries so global commerce dries up. Shortages become a way of life. Widespread
deprivation kindles violence, terrorism escalates, and a large scale war may loom.

Even in this case, the dollar would likely be the world's safe haven. Decreasing prices enable
those who have cash or U.S. Treasury bonds to survive and prosper.

Scenario #3: Recession Reaction.
Likelihood = 15-35%.

Panic sets off contraction in consumer spending which cascades through the economy. Classic
recession response, including lay-offs, unemployment of 10-15% in US, higher in other countries. The Euro may be destabilized by conflicts in monetary policies of member nations. Cutbacks in inventories closes factories; bankruptcies increase. Portfolio Panic Reaction leads many people to take foolish risks.

We work closely with clients to manage their endogenous risks, rebalance portfolios accordingly, make sure that adequate liquidity is maintained.

Scenario #4: Volatility Eruption.
Likelihood = 25-40%.

We are likely experiencing this phase now. Market prices in securities, commodities, housing, etc. take huge swings in waves of panic trading. Investors retreat to the sidelines, so trading volumes vacillate. This is how the market finds price balance, by testing the extremes. This could be a relatively short phase followed by onset of recession which could be severe, or gradually recover as markets begin to bounce back.

This is most difficult time for investors. In today's economies this scenario usually stirs
government intervention in the markets. This brings the danger that the money supply is
increased faster than productivity gains which can trigger spiraling inflation. Having a long-
term fixed rate mortgage is the best protection against inflation. Survival in this phase requires
clients to turn off the TV.

Scenario #5: Bounce Back.
Likelihood = 15- 35%.

If governments are successful in shoring up confidence in their economies, and adequate
liquidity is available in capital markets, stable commerce will again emerge. Housing prices
will drop to the point where entrepreneurs can buy up excess inventory and rent out homes
with a positive cash flow. New business formations provide most new employment
opportunities.

The stock market is likely to start rebounding a year or so before this phase kicks in. Clients
guided by Functional Asset Allocation, which we preach, will prosper in this stage since they
will not have sold off their stock holdings. Those who have continued dollar-cost-averaging, (e.g. through their 401-k's, etc.) will enjoy rapid accumulation in their portfolios.

Long-term Outlook:

Likelihood = 98-99%.

As this downturn is relatively severe, it may take another 2-3 years to substantially recover.
Then we will enjoy approximately 5.5 years (on average) of prosperity, which we will soon take
for granted. On the next downturn, we will be again surprised. We will go through though
another down-cycle as we have for the past century. Again we will think that 'it is different
this time.' A year or so into that downturn we will again anguish about "How Bad Can It
Get?" Then I will send out this article again, as I did seven years ago in Nov. 2001…

Sleep well tonight! Bert

Labels: , , , ,

posted by The Office Grapevine at 9:21 AM 0 comments