Archives for 2010

Why Does The Investment Industry Like Mutual Funds So Much?

Did you know that there are more mutual funds than there are stocks? Have you ever wondered why mutual funds are such popular investment vehicles? Conventional wisdom will tell you that mutual funds are popular because they are less expensive than stocks because they do not carry hefty commissions, they allow the little guy to invest in the markets because the start-up capital can be small, they offer diversification because they hold many investment positions, and finally, they are managed by professional money managers. Unfortunately, these are the reasons given to investors, but the truth is that mutual funds are popular because mutual funds are extremely profitable to the investment industry.

Mutual funds may seem inexpensive because the costs are hidden. Mutual funds are loaded with fees such as sales charges, management fees, and 12b-1 fees. Sales charges are front-end loads charged by the broker or advisor for buying mutual fund shares, and charges for selling mutual funds shares are back-end loads. These charges depend on the various classes of shares. For example, Class A shares usually have front-end loads and Class B shares usually have back-end loads. Front-end charges can be as high as 8.5 percent for Class A shares. This means that an investor with $10,000 is only putting $9,150 to work while $850 goes toward the sales charge. In addition to sales charges, someone has to manage the fund and therefore, also has to be paid a management fee. This fee can range from 0.10 to 2.00 percent per year and depends on the fund itself and its investment style. Another type of fee is 12b-1 which is paid to brokers or advisors to pay for marketing, distribution and service costs. The Financial Industry Regulation Authority (FINRA) allows funds to charge 12b-1 fees as high as 1.00 percent on an annual basis.

Adding up all of the fees, it is no wonder that mutual funds are popular on Wall Street. It’s a great business because everyone except the investor benefits from this investment vehicle. Unfortunately, for the investor, the returns are not as good as the investment industry promises. The average investor in a stock-oriented mutual fund generated 5.66 percent per year over the ten-year period ended December, 31, 2007, according to a study by Dalbar, Inc., a leading financial services market research firm. Notice that this doesn’t include the stock market decline in 2008.

But are all mutual funds bad? No, not all mutual funds are created equal. Saying that all mutual funds are the same would be equivalent to saying that all restaurants are the same. Mutual funds are simply investment companies that make investments on behalf of their investors. There are some mutual funds that delivered fabulous investment performances for its investors and did not charge outrageous fees. But the problem is that most of the investment public would never know about them because these funds don’t advertise much, and they don’t pay high commission fees to entice brokers and advisors to sell them. In other words, they don’t play the Wall Street game.

This is a guest post by Mariusz Skonieczny. Mariusz is the founder and president of Classic Value Investors, LLC, an investment management company. He is also the author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market.

Traditional And Roth IRA Contribution Limits And Phase Outs

By Mr. Money 1 Comment

A while back the IRS released their 2010 Traditional and Roth IRA contribution limits. It's a good idea to make sure and watch those limits from year to year to make sure you're investing the full amount possible.

As was expected in most circles the 2010 Traditional and Roth IRA contribution limits will stay the same for the upcoming tax year.

2010 Roth IRA And Traditional IRA And Contribution Limits

The Traditional and Roth IRA 2010 tax year contribution limits are $5,000 for those under the age of 50. If you’re over 50 you can put in a little bit more, you have the option of making catch up contributions to your account, up to the 50+ limit of $6,000.

Note: Remember, you can contribute to both a Roth IRA and a Traditional IRA in the same tax year, but you can’t go over your limit of $5,000-$6000 when the total contributions to the two accounts are added together. Example: If you were over 50 and contributed $2500 to a Roth IRA, you then be able to contribute only up to $3500 to your Traditional IRA.

Here’s are the Traditional and Roth IRA contribution limits for 2010 and for years past.

Year	Age 49 and Below	Age 50 and Above
2002-2004	$3,000	$3,500
2005	$4,000	$4,500
2006-2007	$4,000	$5,000
2008	$5,000	$6,000
2009	$5,000	$6,000
2010	$5,000	$6,000

Traditional And Roth IRA Phase Outs For 2010 Based On AGI

Traditional and Roth IRAs have phase outs if you make a certain amount of money. Single taxpayers with an annual Modified Adjusted Gross Income (MAGI) over $105,000 begin to see their contribution limit drop until at $120,000 it goes away completely. The limits for Married Filing Jointly investors are $167,000-$176,000.

IRA Type	Single	Married Filing Jointly
Roth IRA	$105,000 – $120,000	$167,000 – $177,000
Traditional IRA	$55,000 – $65,000	$89,000 – $109,000

Contribute To Your Traditional Or Roth IRA Until April 15th

One thing to keep in mind with the IRA accounts is that you can open a new Roth or Traditional IRA right up until tax day on April 15th. If you do make a contribution in 2011 before tax day, be sure to specify which tax year the contribution is being made for, 2010 or 2011.

Differences Between Roth IRA And Traditional IRA Accounts

The main difference between Traditional IRA and Roth IRA accounts is when you end up paying your taxes on the money. Traditional IRA account contributions are made with income before it has been taxed. Because the money is pre-tax your distributions will be taxed at withdrawal. Roth IRA contributions are made with income that has already been taxed. Because of that the money will grow and not be taxed at withdrawal. For a complete look at choosing between retirement accounts, check out the article we wrote earlier this week: What Type Of Retirement Account Should I Choose? Traditional IRA, Roth IRA And 401k.

Do you currently have a Traditional IRA or Roth IRA? Do you have both so that you can tax diversify? Are you contributing right up to the limit?

Things You Should Know About The 2010 Roth IRA Conversion Rules

By Mr. Money 3 Comments

Yesterday I wrote about retirement accounts, and talked about which ones are better for different situations. Today I want to talk about another issue that's been getting a lot of press lately, the 2010 Roth IRA conversion.

In the event you've been living under a rock and haven't heard about the Roth IRA conversion event this year, it is basically a one time event where people can convert their traditional IRA’s, SEP IRA’s, Simple IRA’s, old 401k’s, old 403b’s into a tax free Roth IRA account. Because of the conversion event, waves of people are expected to take advantage this year and convert their traditional taxable investment accounts into tax free Roth IRA accounts. Here are the details.

Should I Convert My Traditional IRA To A Roth IRA?

The first thing you need to ask yourself before you even start going down this road of converting your taxable retirement accounts is whether or not it's even a good idea for you in your situation. A lot of people hve explained the benefits or a Roth IRA conversion, while others are saying that the conversion event has been overhyped. Cynics might say it's just a way for our government to collect on future tax money today – at a higher rate than most people would have paid in retirement. Regardless of whether that's the case, there are some things you should consider:

Pay taxes now or later? Do you want to pay your taxes on the money you invest now, or when you retire? The amount of tax you pay can very quite a bit depending upon what tax bracket you fall into either now vs. when you retire. Problem with this – it's hard to know the future and know what tax rate you'll be paying in the future – and whether taxes will increase. (Where's my crystal ball when I need it?)
Is my income too high to contribute or convert to a Roth IRA in the future? If you're a high income earner and you you want to do a bit of tax diversification, this year may be one of your few chances to convert your traditional taxable account to a Roth because of income restrictions.
Do I want to spread out my tax liability from converting? As part of the conversion event people who convert will be able to spread out their tax liability over 2011 and 2012. More time to pay your taxes!

Reasons To Take Advantage Of The 2010 Roth IRA Conversion

Here are a few benefits of converting your taxable retiremenet account to a Roth IRA this year

AGI limit of $100,000 – rule removed: Previously singles and married couples making less than $100,000 were the only ones able to convert their taxable accounts to a Roth IRA. 2010 is big for so many because the $100,000 MAGI rule is lifted, making a conversion possible for even higher earning singles and couples.
Tax payments can be spread out: You'll convert to the Roth IRA in 2010, but the income to be claimed on your taxes and taxes owed can be deferred until 2011 and 2012. Converters can claim 50% of the conversion amount as income in 2011 and the other 50% in 2012. Remember, this is a one year provision for the 2010 tax year only.
Old 401ks can be converted directly to a Roth IRA: Have an old 401k from an old job? You can convert those this year as well.
Your assets grow tax free, and tax free withdrawals: Converting means the money will grow free of tax burdens, and you won’t have to have a minimum distribution requirement until you turn 70 1/2.

Contribution Income Limitations: Still There For New Roth IRA Contributions

One thing to remember about the Roth IRA conversion event is that just because high income earners can convert their taxable accounts, it doesn't mean they can also open and add new contributions to a new Roth IRA. If their income is over the IRA contribution phase out limits, they won’t be able to make new contributions to a Roth IRA.

How To Convert To A Roth IRA

Converting your taxable account to a Roth IRA will be alot like rolling over an old 401k to a Rollover IRA. If you’re not changing the investment company that your funds are with, it could be as easy as filling out a form. The key is to contact a financial professional who can give you advice for your specific situation.

Are you considering whether to rollover a traditional taxable account to a Roth IRA? Will you be deferring on the taxable income until 2011 and 2012? Have you decided not to convert? Tell us why in the comments!

What Type Of Retirement Account Should I Choose? Traditional IRA, Roth IRA And 401k

By Mr. Money 2 Comments

So you're finally out of debt, saved up an emergency fund, and are ready to start saving for retirement. The question that you have now is, what type of retirement account should you choose? An IRA, a Roth IRA or a 401(k)?

If you’re not familiar with these basic retirement account types, you may want to check out IRS Publication 590. It’s free, and it's pretty in-depth in explaining the differences between the accounts. But just to review for this article's purpose – here are the three account types:

Traditional 401k: An employer sponsored retirement savings plan that allows a worker to save for retirement and defer income taxes on the money until withdrawal.
Traditional IRA: A retirement savings plan that allows a worker to save and invest for retirement with pre-tax dollars. Withdrawals are taxed.
Roth IRA: A retirement savings plan where money is invested with post-tax dollars, and are not taxed at withdrawal.

So which account type should you choose for your situation?

IRA Or A Employer Sponsored 401k?

We know that there are some obvious differences in the account types, like tax differences, but there are other non-tax related differences as well.

The 401(k) will often offer a matching contribution from your employer: If your employer offers this, jump on it – it's an immediate 100% return!
A 401(k) often has limited investment options: 401(k) plans will often give you only a limited choice of pre-selected funds and they're often high cost actively managed funds. An IRA will usually give you access to more low cost index funds and other options.
401(k) plans probably usually charge significant administrative fees: A study done by the Investment Company Institute and Deloitte Consulting found that the median employer-sponsored retirement plan charges an administrative fee of 0.72% of assets. (That’s on top of the fees charged by the funds.) By comparison IRA providers usually don’t charge any admin fees at all.

When you examine these three points, I think most people would suggest this example investment strategy.

Put money in your 401(k) until you get the full employer match.
Max out your traditional IRA to take advantage of its lower costs and better investment options.
Go back to your 401(k) and max it out.
Invest via taxable accounts.

Roth IRA or Traditional IRA?

Now if you are able to contribute to a Roth IRA or a Traditional IRA you have something else to consider. Where do you expect your tax bracket to be when you retire? Depending upon where you think your tax bracket will be when you retire, you may want to make a different investing choice.

You think your tax rate will be the same: The ending value of your account will be the same whether you pay tax now or later (Roth IRA Vs. Traditional IRA). With all things being equal, if you expect your retirement tax rate to be the same as your current tax rate, a Roth isusually going to be better. The reason? Roth IRAs are not subject to required minimum distributions and your contributions (with the exception of amounts converted from a traditional IRA) can be withdrawn free of tax and penalty at any time.
If you expect a higher tax rate in retirement: It’s best to contribute to a Roth. Better to pay tax at a lower rate now, than later at a higher rate.
If you expect a lower tax rate in retirement: It’s best to contribute to a Traditional IRA. Better to pay tax at a lower rate later than at a higher rate today.
If you have no idea what to expect, diversify: If you're not sure where your taxes will be, tax diversify and do a little of both. A lot of people do this unknowingly when they contribute to a tax-deferred plan at work, and then a Roth as well.

Have you set up your retirement strategy? What plan did you settle on? Are you going with a 401k, IRA or Roth IRA? Are you tax diversified?

If Your House Is Worth Less Than You Owe, Is It OK To Just Stop Paying Your Mortgage And Walk Away?

By Mr. Money 68 Comments

Since the market collapsed back in 2008 we've seen the real estate market take a nosedive. People who bought at the height of the market (assuming that real estate would always appreciate) found themselves in a situation where their homes had dropped significantly in value. My wife and I are a part of the group who have taken a significant hit, our home value has dropped by over $40,000.

Many people, especially those who bought homes without a down payment, or with a sub-prime loan are now finding that they also owe more on the home than it is currently worth. According to a report by First American Core Logic, a real-estate data firm, more than 11 million families are in “negative equity”, that is, they owe more on their home than it is worth.

Thankfully we aren't underwater, but what about those people who are? What are they to do? A growing group of people are saying that for most of those people it would make complete sense to just walk away from their mortgage, stop paying, and take the credit score impact of a foreclosure. They call it a “strategic default“.

My question is this. Is it OK to walk away from your mortgage if you have the money to pay, just because you're underwater and have negative equity?

Credit Score Impact Of Foreclosure

There are a lot of things to consider when you're thinking about walking away from your home. First of all, you need to consider the financial impact of walking away from your mortgage.

One of the most obvious impacts a foreclosure will have on your financial life is on your credit score. Now, I'm not one of those people who will tell you to constantly check your credit score and rely on it for everything, but the fact is that it does play a part in a lot of things these days, so you can't completely ignore it. So what impact does a foreclosure or delinquent payment have on your credit? Fair Isaac pulled back the curtain a bit and revealed a little bit about what kind of a credit score impact those things might have:

30 days late: 40 – 110 points
90 days late: 70 – 135 points
Foreclosure, short sale or deed-in-lieu: 85 – 160
Bankruptcy: 130 – 240

So having a late payment, a short sale, foreclosure or bankruptcy can have a pretty significant impact on your credit score, and mean you'll have to improve credit score later. In any of those situations it is going to show up on your account and have pretty negative impact. What does a lower FICO score potentially mean?

Absorbing a big credit-score hit can make many transactions more costly. It's not just paying more for credit card debt and auto loans, insurance can cost more as well.

The average savings for someone with a good versus mediocre credit score is about $115 a year for auto insurance and $60 for home, according to Loretta Sorters, of the Insurance Information Institute.

A low credit score can even make it harder to rent a home because landlords often use credit scores to weed out prospective renters.

So having a foreclosure, short sale or even late payments can mean you'll end up paying more for a variety of things. Definitely a huge impact to consider when you're thinking about walking away.

Moral Dilemma Or Just A Contractual Transaction?

While walking away from your mortgage will obviously have a negative financial impact, especially as it relates to your credit score, this still isn't enough for many people to not consider it. There are still those who are just having a hard time making ends meet, and while they can still make the payments, they would prefer to just walk away from the hefty mortgage on their underwater home, because they don't want to lose upwards of $50-100,000 (or more) on their home value. Why take the hit when the bank can better absorb the blow?

It does seem to make sense on the surface, but now we need to ask the question, is backing out of a mortgage contract an OK thing for a homeowner to do, or is it morally wrong to back out of a contract you are still able to fulfill?

Personally I tend to come down on the side of paying your obligations if you're able. I like to think that a contract is something you live up to. You knew the terms of the deal when you signed up, and now you should live up to it if you can. We need to be responsible for the obligations that we've made.

Others would counter that a strategic default is a legitimate option that is even spelled out in the mortgage contract, where specific ramifications of a foreclosure or short sale are spelled out for the homeowner. To exercise those options is just a a part of the legal transaction.

I understand that argument, but don't agree with it. Just because the ramifications of missing payments or defaulting are spelled out in a contract, doesn't mean it is an acceptable or desirable thing to do. Also, there is nothing in the mortgage agreement that makes your continued payment contingent upon the value of the home going up! It is a risk that you take!

What do you think? Should morality come into play when making a decision about a strategic default? Is it just a contractual transaction, and should we not feel bad about defaulting or going into foreclosure? Tell us what you think in the comments!

Lending Club Review And Account Opening Process

By Mr. Money Leave a Comment

A while back after reading about peer-to-peer lending (or social lending) via a variety of personal finance blogs I decided to look into it a bit more. The idea sounds intriguing. Instead of dealing with big banks who could care less about providing good rates, good customer service or giving you a personal touch, you borrow money from other regular people – all who are lending you as little as $25 a piece. You get a lower rate and they get a better return than the 1.5% offered via their savings account. Everybody wins.

While I liked the idea itself, I wasn't sure what the risks might be when engaging in this type of lending. What were the default rates, and what kind of returns could you expect when investing your money? Would it last?

There were a couple of main players in the Social Lending arena, among them Lending Club and Prosper. Lending Club was the one that I decided to give a try.

Opening A Lending Club Account

Opening an account with Lending Club is a pretty easy process. First, however, be aware that Lending Club and other P-2-P sites are not available in all states. To check the availability of becoming a lender, check out this link.

After determining if LC is available in your state, click on this link and it will take you to the signup page. When signing up you will follow this process:

Click on Join Now link at the top right of the screen and complete the application to be a borrower or investor on the screen that comes up. Sign up through us and you should get $25 to start your account!
You'll get a confirmation email. Click on the link in your email to confirm your registration.
Go back to the Lending Club website and login with your new login info.
Click on the Invest button. Fill in your profile information in order to verify who you are, and to link your bank account to Lending Club. (Lending Club will make two small deposits into your account to verify that you have access to the account).
Once your bank account is verified, go to the My Account tab, and then choose Add Funds. You’ll need to transfer at least $25 to your Lending Club account in order to get started. This may take a few days.
From My Account tab, click on Invest to start lending money

Lending Money Through Lending Club

Once you have added funds to your Lending Club account, it's time to start investing! This is the fun part of the process. Just click on “invest” on the navigation bar, and it will take you to the Lending Club automatic “Build A Portfolio” screen. You can either let Lending Club choose loans for you in $25 increments (Using a conservative, moderate or aggressive setting), or you can choose to browse notes manually and select the loans you want to purchase.

Choosing the loans can actually be kind of fun. You get to browse through listed loans that are going through the funding process, and fund the ones you feel are good credit risks. If you want you can even choose to ask questions of possible borrowers.

For me, I'm a less aggressive lender, so I tend to follow these criteria in the loans I choose.

Loans less than $10,000: Lower loan amounts means a lower monthly payment and a lower risk of defaulting on their loan.
A & B credit rating: I’ve invested in loans that have either an A or B credit rating (good credit). I've also sprinkled in a few C ratings for flavor. Never anything lower.
Zero delinquencies: When you view borrower’s profiles you can see from their credit report if they’ve had any reported delinquencies on their account. If they have, I skip their loan. If they’ve been late in the past or missed a payment – they’re likely to do it again.
Debt to income ratio below 25%: I like to invest in loans where the borrowers have a lower DTI ratio. You want to make sure they can afford the loan!
Loans over 60% funded: I like to do my due diligence when giving out a new loan. But when enough other people have invested in the loan, that's usually a good sign as well.
Borrower answers to investor questions: Lenders can ask borrowers questions before they purchase a piece of their loan. If answers aren't forthcoming, or if the person seems flaky, I skip the loan.

So those are some of the criteria I have used to find good loans in my Lending Club account. After lending for about a year it has worked well so far, I haven't seen any defaults on the 35 notes I have bought in on. My net annualized return is currently around 10.30%. That's better than a high yield savings account, and part of the reason I'm adding more money to my account this year!

Using Lending Club As A Borrower

You can also use Lending Club as a borrower. I have read quite a few interesting stories on the personal finance blogs of people getting a loan to help pay off high interest credit card debt, or second mortgages. Usually they do this because they can obtain a better rate through Lending Club than through their bank.

I would never suggest consolidating all of your loans into a Lending Club loan unless all the rates are higher than the rate you can get with Lending Club.

When you're borrowing there are currently only 2 loan terms you can sign up for:

36 Months
60 Months (only recently added this past month)

You can borrow up to $25,000 from other Lending Club users, and the rate you receive will depend on a variety of factors including your credit score.

It isn't for everyone, but for some it's a good alternative to the big banks.

Conclusion

I've been investing in Lending Club for over a year now, and in that time I've made a net annualized return of 10.30%, and due to my careful lending habits – I've had zero defaults on the loans I chose to fund.

Lending club can be a great investment option, as long as you are careful about who you're lending to, are sure to keep reinvesting the funds that you're making.

As a borrower it can make sense as well, as long as the loans you're getting are lower than rates you can get elsewhere. If they are, why not? You're then paying interest to individuals instead of a big bank!

What do you think of Lending Club? Have you used it as a Lender or Borrower? What have your returns been like? Have you seen any defaults in your account? Tell us your thoughts on Lending Club and social lending in general in the comments.

Sign up for Lending Club Now! Details Here

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