Guidance on managing $s

My immediate thinking is the first pay off both loans first.

You are sitting on cash/bonds earning between 0-5% while paying interest on loans costing 6-9%, and this odd strategy is reducing your net worth every day you continue it. What you should be doing is using the cash and bonds to pay down the loans.

Andy

Okay. I was planning on using some cash on some other land investment overseas that has a potential to increase in value - but it didn't work out. Right now, I will pay down the loan as much as possible. Just another question, I see lot of mutual funds doing quite well (atleast some of the sector funds I have yielding ~10%-15%). Is it a good strategy to use them instead of stocks ? i.e wait for it to grow and reinvestment after some growth (Even with the penalty it may have with premature pullout, it looks like it may work out since my stocks are just breaking even). Any thoughts ?

"really_novice_investor" wrote Re his roughly $130k of savings:

I agree with Andy that this is a good choice.

For how many years have they been returning this much? This is a very important question that will lead you to a better understanding of market behavior.

How confident are you that you can pick stocks that are winners for the long run? Exactly what justification do you have for your confidence? Have you studied the historical behavior of stocks?

We have been in a ridiculous bull market for the last few months. If you have not lived through a major market correction such as that from 2000-2001, or that in 1987, you likely have dollar signs in your eyes, now possess something of a gambler's addiction, and need to read.

Also, you should start becomine well-versed in asset allocation and why it's a good strategy for the long haul. For an introduction, try some of the free online tools at

. You also need to identify your short and long term investing goals. E.g. do you have an emergency fund? Saving for a house? Saving for retirement? Have you a 401(k) plan with matching? What are the matching terms? Have you started a Roth IRA? Do you know the pros and cons of 401(k)s and IRAs?

Pay the $40K 9% loan with the ING and bank money.

Pay the other $40K loan with the bonds, the stock market money, and $1 from the bank.

Put the remaining $4K of bank money into a good money market account for emergencies.

Cash out the company stock. You need to be diversified, so you don't want stock in the company that writes your paycheck. Put the money in the same funds that are doing so well for you in the 401K (don't mix the money, create a 2nd taxable account that holds those funds).

This leaves you debt free, with an emergency fund, some good performing investments, and a retirement account.

-john-

Elle,

Thanks for your response. I guess you are asking the right questions that I need to think about.

1. Mutual funds - The returns I quoted are for the past 1 year (never had any mutual funds open before :(
2. Stocks - Confidence level w.r.t stocks is not all that high . Your guess was correct regarding 2001 as I wasn't in US at that time (infact the savings are from the past ~5 years of my stay in US. I am 30 for reference)
3. Another reason why I never touched the bank a/c to pay for the loan was that I wanted to keep the $s for emergency. But it looks like I can afford to pay off the loan a little bit
4. No matching 401K from the employer. So I have minimal in 401k (~2K). The 8K is actually Roth IRA. Can one contribute to both Roth IRA and

401K same time ?

Thanks for the link. I will check them out.

Elle wrote:

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You might also consider employing a flat fee financial advisor for their thoughts.

You forgot to mention your age, responsibilities, and risk profile.

Gut feel...that's a lot of money tied up in one security. i had built up a lot in my employers stock that i have been liquidating to reduce my exposure if they go in the toilet.

Seems low to my tastes given how much you have in your ESPP.

9% is a pretty ugly rate. 6.75 isn't bad, but you can do a lot better now that mortgage rates are in the 5's again.

Paying off the 9% somehow sounds like an excellent move. Liquidating some of the ESPP to do it sounds good too. The only thing to consider though is the tax impact and if there are strategies to minimize that.

If your investments are positioned to do better than 6% and you can tolerate the risk, refinancing your mortgage and paying off all other loans with it may be one thought. The benefit of mortgage interest is its ability to be deducted from your taxes, assuming you have enough of it.

Is the ING in terms of whole life insurance?

These are just random thoughts based on what I'm seeing. You have enough questions where it may be worth paying an independent financial advisor (who isn't paid by commissions on products they have to sell) would be excellent for you.

-- Todd H.

"really_novice_investor" wrote

Then I recommend sticking with funds for awhile and continuing your exploration of this subject via (1) lurking here and at other financial fora; (2) asking questions whenever something does not make sense to you; (3) skimming some of the books at

. Maybe start with the first (the Tobias book), skim the chapter titles and read/skim what looks interesting, then move onto the second. Plan on returning to some of the books as your interest allows. For starters, you could even start a thread with the subject "How to Pick Mutual Funds."

Because there is no matching, and before you consider adding another dollar to your 401(k), you should look further into the minutiae of its offerings. I think joetaxpayer's site

is a good overview of some of the pitfalls of a non-matched 401(k). The biggest concerns are (1) high mutual fund expenses which can easily offset the tax advantage; and (2) lack of diverse choices. Joe says this site of his is a draft at this point, but it still reads pretty well right now.

Absolutely. Many consumer sites exist to help you with the details on Roth IRAs and 401(k). Googling for {Roth IRA limits} for example turns up a bunch.

You are asking excellent questions. I trust you are aware that this is a first step to becoming a master of the financial universe and so your destiny.

Absolutely.

401k is typically the superior vehicle because contributions to it are done with pre-tax dollars, not your take home post-tax pay. That is, 401k contributions reduce your taxable income amount on your tax return while roth IRA contributions do not.

Also, the limits are much higher with 401k in terms of how much you can save. Up to 18% of salary I believe up to whatever limit, while roth is capped at something much lower (4k i believe).

Just because your employer doesn't match contributions doesn't mean it isn't something you should focus on more. Look into the benefits of

401k investing more, and when you change employers, don't forget to roll that stuff directly over into a rollover ira. Don't let it sit and get hit with maintenance fees and such. :-)

Best Regards,

-- Todd H.

"Todd H." wrote

I suggest you read up on the pros and cons of the unmatched

401(k) vs. the Roth IRA. From my reading, it is not at all "typical" for the unmatched 401(k) to be the superior vehicle.

[401k vs. Roth IRA]

While the deductibility of contributions does differ, the net judgement (that one is better than the other) is 100% wrong. They are different, and can have some differences as far as ultimate spendable returns (depending mainly on changes in one's marginal tax rate), it's mainly a wash with respect to the deductibility. 401k contributions, while earning one a tax deduction now, lose out later on when one pays income taxes on both the gains and on the original contributions when they are distributed to the investor.

See a recent thread here where I compared the net results of investing in a regular IRA (or 401k), a Roth IRA and investing after-tax in highly tax-efficient vehicles - assuming the same tax rates, the same amount invested, the same return on the investments themselves - and the net results from those investments. The 401k and Roth are identical given those assumptions, in the end.

This part is true enough. But do take care to look at the costs in your 401k. The 401k, especially with an employer match, is one of the best deals going for most workers. But it's not without its issues, and there are some 401ks with miserable investment choices, very high fees and other problems. The 401k *can* be amazing, especially with an employer who does the right thing. But it can also be a real stinker.

Thanks a bunch for all those (Todd/Elle/Andy/John, others if any) who have replied.

Todd - My understanding is the same as Elle (i.e Roth IRA is better than unmatched 401k. While in 401k you reduce tax for the calendar year and save $s, when you pull it out at retirement age you may pay lot of taxes on the amount accrued. Roth IRA is already taxed, but ofcourse no savings in tax in the current calendar year). I also read that by 2010 traditional IRA's can be converted to RothIRA's. My age is 30, married, no kids (yet). What I have is combined assets.

I forgot to mention one important thing, rather didn't clarify. I have ~250K mortgage at 5.375% at 30yr fixed (1 year has just passed), and the 40K was the home equity loan was at ~6.75%, 10 year fixed. My understanding is that it is better to pay off the smaller loan first than the first one due to tax benefits (i.e instead of reduced 250K to

210K, finish off the 40K first).

I will certainly consider approaching a tax advisor, but I am just trying to get some clarity on the possible questions I may have.

Thanks again!

news: snipped-for-privacy@panix1.panix.com or

One of your assumptions was different from this. You assumed the same amount of money, pre-tax, to invest. The amount actually invested in the Roth IRA was less, because some of that pre-tax money was used to pay taxes.

:: IRA: :: Pay no taxes now. Invest $100K ... :: Roth IRA: :: Pay taxes now on the $100K, invest $75K

Precision is important, because you had another unstated assumption - that one didn't have enough pre-tax money to max out the Roth. If one did, as I showed in a followup, the Roth was superior (with all other assumptions as stated above).

news:kZ5ch.189$ snipped-for-privacy@newssvr13.news.prodigy.net or

Nevertheless, I absolutely agree that if one is cash limited (as opposed to limited by legal maximums on contributions), then a Roth contribution(whether IRA or 401(k)) is no better or worse than a pre-tax contribution (whether IRA or 401(k)), in terms of dollar/net tax results.

There are, of course, other factors. Many large 401(k) plans offer cheaper institutional shares of funds than one can get at the retail level (on the other hand, many small 401(k) plans are wrapped in annuities that cost more than a retail IRA).

As someone pointed out in another thread, a (traditional, not Roth) 401(k) will reduce your adjusted gross income(AGI), which can have all sorts of good effects like making you eligible for a Roth conversion. (Contributing to a Roth won't reduce your AGI).

Mark Freeland snipped-for-privacy@sbcglobal.net

That's not an issue of investment performance - but rather one of investment availability. The effective pre-tax limit on a Roth IRA is higher than the effective pre-tax limit on a regular IRA because the limit is applied after-tax on the Roth. But, again, assuming the same quantity of money is available to invest in both cases

*and* that the quantity will be below the limits, the performance is otherwise identical.

If "superior" means "has a higher limit". To someone who earns above the income which lets one invest in a Roth, then, I suppose you'd say the Roth is "inferior" rather than simply "unavailable". Okay by me. Of course, if "has a higher limit" alone is the criteria, then VAs, well, let's not go down the VA road...

That would have been, um, me.

Nits aside, the bottom line is, generally, to all folks who qualify (ie. have income and it's below the threshold), putting money into a Roth is a good thing. Having a 401k is a good thing. Max out both if you can. If income doesn't permit it, then chances are that income's low enough to do the Roth - as Elle points out all the time, then, do the 401k up to the match, as much Roth as one can, then, if there's still funds available, 401k as much as possible.

The question's a little trickier for folks who can't put money into a Roth at all (usually due to too much income) - in which case, if they have a 401k, they should probably max it out unless it absolutely stinks. But the tricky part is whether or not it makes sense for that person to put non-deductible contributions into a traditional IRA, to get a low-cost VA, to just buy some tax-efficient index fund and put it away. FWIW, I lean towards loading up the IRA anyway (possibly with the chance to do a Roth conversion later on), and then manage taxable investments with an eye towards tax efficiency (ie. by harvesting losses sometimes, etc).

Should also be interesting as Roth 401k plans start to be more widespread.

One other thing I was just thinking about recently with respect to estate taxes - a Roth conversion may also help lower the value of an estate - by prepaying the taxes on the distributions from the IRA. If someone has an estate big enough that at the margin, it's going to get hit with estate taxes (up to 45%), then every dollar used to pay taxes on a Roth conversion before death is a dollar less to be taxed as estate taxes - and as we've discussed above (assuming same rates of return and of taxation) that has no after-(income)-tax impact on the spendable amount resulting from the IRA investment.

Contrived example - 25% marginal tax rate (on both owner and his heirs) and an estate consisting of (a) a bunch of other stuff (enough to put the estate up into the realm of estate taxation, say $2million now, and the 2007 marginal estate tax rate of 45%) (b) say, $150,000 of cash/investments in a taxable account and (c) $100,000 in a Regular IRA.

The person dies and the estate pays 0.45 * $250,000 = $112,500 out of the cash to cover estate taxes owed on the IRA and the cash. That leaves (b) and (c) at $37,500 and $100,000 respectively. Now, suppose the heir wants to spend all he got in (b) and (c) - he pays income taxes of $25,000 on the IRA distribution, leaving, out of the original $250,000, only $112,500 spendable.

Now, suppose that the $100,000 got converted to a Roth - and the taxes on the conversion, $25,000 were taken out of the cash in (b). The estate now looks like this: (a) (stuff) (b) $125,000 in cash/taxable (c) $100,000 in Roth IRA Now the person dies and the estate taxes due on the combination of (b) and (c) is 0.45 * $225,000 = 101250, leaving the (b) and (c) looking like this: $23,750 and $100,000 respectively. If he wants to spend all of it, there are no more income taxes due, so the whole $123,750 is spendable - ie. since the income taxes were paid with pre-estate-tax money, he's ended up with $11,250 more to spend. Note that that $11,250 is precisely the estate tax rate times the income taxes due on that conversion, and relative to the amounts of money involved here, a huge difference.

Of course, much of that example is contrived - assumption of the tax rate, for example - a big Roth conversion could bump into tax brackets - assumption that the heirs cash it all out and spend it at once - assumption that the heirs have the same tax rate as the original owner - etc. etc. Nevertheless, it looks like Roth converions - help with estate tax issues, even without considering distribution rules.

Ugh. As if this stuff weren't messy enough *before* considering estate taxation issues.

Interesting thought, but not quite analogous. In the situation above, one is not forced to choose between the Roth IRA or a deductible IRA (for the sake of argument, assume one is not an active participant in a retirement plan). Rather, contributing the maximum ($0) to the Roth does not diminish the amount one can contribute to the traditional IRA.

In order for something to be labeled "inferior", it must be inferior to something else. No choice is required here, one can contribute to both IRAs, so there is only one sane alternative (contribute to both), and thus neither a superior nor inferior option. (Admittedly, contributing $0 sounds absurd.)

To get rid of the $0 nonsense, consider a traditional 401(k) vs. a Roth IRA. Here, the limits on both are non-zero, so we eliminate the $0 distraction. They still have unequal limits, which was your key condition. Which is better - the 401(k) or the Roth IRA? That question reflects a false dichotomy, for it is not an either-or situation. The superior choice is "both", as you opine below.

In contrast, with $5K in pre-tax dollars (25% bracket), one is forced to choose between a Roth IRA and a traditional IRA + $750 in a taxable account. Those are the actual choices; one merely abbreviates them as Roth vs. traditional. The former gives you more after-tax dollars at the end of the line (end of story?).

Yes, yes, yes!

One doesn't necessarily need a big conversion to get bumped up. For example, in NYS, the first $20K of pension distributions (including IRAs) are excluded from state (and city) taxes. With your example, say around age

80, the MRD would be somewhere in the $10 range, leaving only $10K for conversion without hitting a sizeable bump in local income taxes. People tend to forget about local taxes when they run the numbers.

Some of this depends on how close to the borderline one is. Simply making tax-free inter vivos gifts ($12K/recipient/year) may suffice. Or the estate may be shrinking over time, as the owner pays for medical expenses in late retirement.

Now consider 2011. Do you want to try to reduce the estate to $1M, or grow it with the hope that Congress will make the $3.5M exemption from 2009 permanent?

Don't you just love December tax planning?

Mark Freeland snipped-for-privacy@sbcglobal.net