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TIPS: Inflation Protection For Your Portfolio

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One of the most insidious threats to your ability to build wealth in the long run is inflation. Inflation is a reduction in your buying power that can make retirement a bit difficult. Keeping your money in a savings account — especially with the low yields we see now — might mean that inflation causes you to lose money sitting in the bank. The same is true of bonds when they have low yields. However, some investors are uncomfortable with relying too much on stocks to help them beat inflation. If you want to add a little more stability to your portfolio while keeping pace with inflation, TIPS might be a workable solution.

What Are TIPS?

Treasury inflation-protected securities (TIPS) are bonds offered by the U.S. government. They are designed to keep pace with inflation, since the principal is adjusted at regular intervals to reflect changes in the Consumer Price Index. The face value is adjusted according to the CPI, and the yield is paid on that higher principal. Realize, though, that deflation can mean that your TIPS principal might be adjusted downward (although never below what you paid).

TIPS Treasury Inflation Protected Securities
Even with recent troubles, and talk of a possible credit downgrade, many still consider U.S. Treasuries the most reliable bonds in the world. The risk of default is always there, but it is generally considered a very low risk.

Things To Consider Before Investing In TIPS

Before you get excited about TIPS, you need to take a few things into consideration. They can work well in your portfolio, and provide you with peace of mind and some help beating inflation. But you need to keep a few things in mind about them:

  • Yields are generally lower than other Treasuries: Because of the principal adjustment, TIPS have lower yields. There are some instances that — even with inflation in the equation — you can do better overall looking into higher yielding bonds.
  • You pay income taxes on TIPS adjustments: If you have a net increase in your TIPS principal over the course of the year, you have to pay income taxes on that amount, at your marginal tax rate. You won't receive the cash payout until your bond matures, but you still have to pay taxes on the income. Many people like to hold TIPS in tax-deferred accounts for this reason.
  • Treasury Direct doesn't provide TIPS for IRAs: One of the reasons that people like TIPS is that you can get them from Treasury Direct without paying fees and commissions. However, the government doesn't offer this service for IRAs and Roth IRAs. In order to add TIPS to your IRA, you have to go through a broker. Some brokers will let you add TIPS to your IRA fee-free — but only if you purchase a minimum amount.
  • CPI might not accurately reflect your personal inflation rate: A debate among economists and others rages about whether CPI is a “good” measure of inflation. In any case, TIPS won't protect you in the event of rising interest rates in other areas of life, and CPI might not accurately measure your own personal rate of inflation. Take this into consideration as you determine whether or not TIPS are a good inflation hedge in your particular situation.

TIPS really can be a good addition to your portfolio. However, like all investments, you need to carefully consider how they would fit into your overall goals and financial plans.

How To Avoid The Capital Gains Tax

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Investments are difficult enough without losing huge portions of your investments to taxes, and capital gains are no exception to taxes. Capital gains are the profits that come from investing in capital assets, such as stocks, bonds, or real estate. If the profit exceeds the purchase price, which is what we all hope for, then the difference between the higher selling price and the lower purchase price is considered a financial gain for the investor, which is subsequently taxed. However, there are a few ways to get around paying large amounts of your investments. These are all legal, commonly used, and designed for investors to maximize their investment gain, without losing hard-earned funds to taxation.

“The government always wants its portion, but donating is one of the ways around tax requirements,” said Charles Bulger from RetirementCalculator.com. If you bought stocks in the past for 2,000 and the stock is now worth 10,000, you can donate the shares to charity for a tax deduction of 10,000 without having to declare the 8,000 profit as a taxable gain in capital. This is a common device used by investors called a charitable gift trust, which is offered by brokerage firms. You are allowed to donate a block of appreciated stock over a period of years, and the stock is sold by the trust, not the investor. No capital gains tax is applied.

If you’ve made some gains in your stock and you’re in a higher tax bracket, the appreciated stock is going to get hit with some hefty taxes at a higher rate. To bypass this tax, you can transfer the stock to a family member who ranks in a lower tax bracket. The gain would be placed on their tax return and, if the tax rate is low enough, they could end up having to pay much less than you would have. There are some drawbacks to this type of gift. Over 13,000 will eat into your lifetime gift and estate exclusion. Talk with your broker about this option, and see if it would work to your benefit.

This option is for those who are not relying on investment for financial support. If you want to bypass paying any gain taxes, consider your stocks, bonds, and other investments as one portion of your will. Death is one extenuating circumstance around taxation. It sounds morbid, but it’s one way of keeping the government out of your investments. Your heirs never have to pay income tax on the appreciated value between the time of purchase and your death, which your investments in their entirety to the next generation.

These are just a few of the many ways you can get around paying huge sums to the government. Forbes also has an article that goes into other ways that consumers can get around this form of taxation. As always, you should consult your broker and discuss in greater detail the usefulness of these types of actions. Looking into some of these options can save you a lot of money, and can help keep government hands out of your hard earned cash.

Can Identifying With Your Future Self Get You To Save More For Retirement?

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Our country is currently going through some hard economic times, with record numbers of people being unemployed, or out of the work force. So when folks finally get back into the workforce, it can be tough to even begin thinking about setting up a retirement plan and saving for retirement. The problem is, time waits for no man (or woman). People are in danger of having to drastically reduce their lifestyles in retirement out of necessity. In fact the Center for Retirement Research at Boston College found that 51% of American households are at risk of being unable to maintain their standard of living in retirement, up from 43% in 2004.

While we continue getting older, unless we're regularly saving for our retirement, our retirement is becoming less and less sure. So what is it that people need to get over that hump and be convinced that they need to be saving and investing for retirement? What are some things that can help make them more likely to save?

Visualizing Your Future Self

One thing that researchers have found is that people have a hard time thinking about the future because it seems so distant, because they don't know how to think about what their wants and needs will be in the future and because they can't really identify with where they'll be 20-30+ years in the future.    In other words, they can't identify with their future selves.  Excerpts from the WSJ:

Staring into a mirror today and seeing yourself as you will look in the year 2057 is unnerving. But that may be just what it takes to shock Americans into saving more. At Stanford and other universities, computer scientists, economists, neuroscientists and psychologists are teaming up to find innovative ways of turning impulsive spenders into patient savers…

Behavioral science offers at least a partial answer: To make long-term financial goals more achievable, you must make yourself feel as if the future is now.

The project underway at Stanford seeks to close this gap between the present self and the future self, without turning young people into misers. By enabling the young to see themselves as they will be when they are old, virtual-reality technology can transform their urge to spend for today into a willingness to save for tomorrow.

William Sharpe, the Nobel Prize-winning economist who co-founded Financial Engines Inc., a firm that provides investment advice to retirement savers, says, “The idea of getting people to feel sorry that ‘Poor old me, at age 70, is going to need help if I don't save more now'—I regard this not as persuasion, but as additional information.” After he heard about the technique, Prof. Sharpe asked to monitor the research and became a co-author of a forthcoming study on its effectiveness. “It's very promising work,” he says.

What they found was that when people were put in a situation where they had to identity with how they would look and act in the future, they were more likely to be open to investing for the future.  Why? Because of what they call the “Proteus Effect”

The Proteus Effect

So what is the Proteus Effect?  In it's simplest terms, it's behavioral alteration in the real world triggered by changes in how our bodies appear to us in a virtual world.  In other words, things that happen virtually have a very real effect on us.

Experiments have shown that if you are sent into a virtual-reality environment with a particularly good-looking “avatar,” or digital self-image, you are likely to become more sociable. Seeing your avatar exercising in a virtual world can spur you to add an hour a day to your exercise routine in the real world; people whose avatars do the dirty work of sawing down a virtual tree use less real paper later in the day. Given a taller avatar, you will act more confident and negotiate more selfishly.

What researchers also found was that when young people were shown future versions of themselves, they were much more likely to want to save for retirement, probably because they were more able to relate to their future selves, and realize they would have a need for money in the future.

“People who see their future selves end up being more patient,” says Hal Ersner-Hershfield, a psychologist at the Kellogg School of Management at Northwestern University, who led the project.

In one experiment, young people who saw their elderly avatars reported they would save twice as much as those who didn't. In another, students averaging 21 years of age viewed avatars of themselves that smiled when they saved more and frowned when they saved less. Those whose avatars were morphed to retirement age said they would save 30% more than those whose avatars weren't aged.

Real World Applications

So how can we take the knowledge that feeling more in tune with your future self can help you to save, and use it to our advantage?  For starters, why not create your own age morphed photo?

Create an aged picture of yourself to put on the refrigerator or on your computer – and use it to remind you of your need to save. One great site to do that at is In20Years.com.  You just upload a photo of yourself and it will instantly age you by 20 or 30 years.  It's quite eye opening to get an imagined version of yourself – that far in the future. Here are a couple of examples done using that site, with the originals in the lower right corner:

I know when I did it for myself, it certainly made me feel a bit more of a sense of urgency to save.

What are some other possible real world applications of age morphed photos?  The article suggests some:

  • Placing age morphed photos on a company's benefits site:  Encourage employees to save for retirement by placing an age morphed photo of them on the company's benefits page, with their approval of course.  It might be a good way to encourage savings.
  • Tool for financial advisors: Financial advisors could use age progressed photos as a part of their practice to help encourage people to think about the future.
  • Brokerages and mutual fund company sales tool:  Companies could of course use technology like this as a sales tool – which isn't necessarily all bad if it gets people to save.

Other Ways To Encourage Saving For Your Future Self

There are of course other things that you can do to feel more in tune with your “future self”, to encourage your savings.

  • Set an actual retirement date:   Studies have found that people are more willing to put off the benefit of future realized savings, if they can imagine an exact date that they will retire. So set an actual date that you would like to retire, and even name your accounts by that date!  For example, The “May 8th 2041 Fund”.
  • Monitor your progress regularly:  Set goals to save towards, and monitor your progress regularly. Even consider setting up prompts in Google Calendar or other software to remind you to go and update your progress on a regular basis.
  • Imagine how you would feel in a comfortable and worry-free retirement: Studies have shown that just taking 3-5 minutes to visualize a trouble free and relaxing retirement every once in a while and using that as a prompt to save works quite well.   People were found to be 25 percentage points more likely to increase their savings on the spot when engaging in such behavior.

What other ways can you think of that can help you to visualize your retirement, and encourage you to save today?  What tips and tricks do you use?  What do you think of the age morphed photos? Tell us in the comments!

Betterment.com Review: Making Investing As Easy As 1-2-3

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There's been quite a bit of buzz lately about a new investing and brokerage account through a website called Betterment.com.

A lot of personal finance blogs are writing about it because it takes a topic that can be confusing for a lot of people, and makes it accessible. 

They take the investing process and make it as simple as 1-2-3.  Sign up, fund and invest.

Ok, let's back up for just a moment. 

What is Betterment?

At it’s very core it’s just another of the online brokerages that we hear about all the time on this site and others.  They allow you to hold stocks and bonds as investments via ETFs, like an account through Scottrade or ShareBuilder. But it’s more than just a brokerage account.  It’s also a tool that helps automate the investing process,  to make it simpler for the average Joe. 

You can set up automatic investments every month, and it will also automatically re-allocate your investments for you on a regular basis. In essence it's a set it and forget it investing solution.

I recently signed up for Betterment to give it a run-through, and today I thought I'd do a quick review of Betterment.com.

Quick Navigation
Betterment History
Recognition & Awards
Simple Investing? How Simple Can It Get?
Forecasting And Visualization Tools
Portfolio Out Of Whack? Automatic Re-allocation To The Rescue
What Does It Cost?
I’ve Signed Up For Betterment

Betterment History

Betterment.com was founded back in 2008 by Jon Stein.  While it was founded back in 2008, Betterment.com only recently launched at TechCrunch Disrupt 2010 NYC. In December 2010 Betterment.com received $3 Million in a series A financing round from Bessemer Venture Partners (lead) and Anthemis Group.

Betterment LLC is a Registered Investment Advisor with the SEC and they’re SIPC insured.  You can be assured of the same protections as you would with a larger financial institution.  Of course since this is an investing account and not a savings account, there is no assurance of not losing your money.

Betterment only launched a few months ago, but because they've got such an innovative concept, it's receiving a ton of buzz.  They've received writeups in The New York Times, CNNMoney, Investment News, Mint.com and more.

Recognition & Awards

While Betterment has only been around since the end of last year, they've already started garnering a ton of attention, and a few awards for their trouble.

  • TechCrunch Disrupt NYC 2010 “Battlefield Finalist”
  • TechCrunch Disrupt NYC 2010 “Best NYC Startup”
  • FinovateFall 2010 “Best of Show”

So while they have just launched folks are already starting to recognize them and their concept as a powerful one.

Simple Investing? How Simple Can It Get?

So what's the idea behind Betterment?   Their basic idea is this – so many folks in this day and age are either too busy to get too involved or too intimidated by the complexity of investing that they just don't do anything at all.  Betterment looks to take all of that away by just making investing simple, and removing a lot of un-necessary choices. Here's a video run-down of how Betterment works:

http://www.youtube.com/watch?v=qArLnDl5YuY

So when you sign up for an investment account with Betterment, the process will be as simple as choosing:

  • How much to invest.
  • How much of your investment you want in equities (Stock Market).
  • How much you want in Treasury bonds (TIPs).

You can also set up automatic investments on a regular basis if you want to.

Within stocks and bonds, they divide up your holdings into a variety of ETFs so that you are diversified.   Here is what you get on the stocks side:

  • 10% SPDR Dow Jones Industrial Average ETF (DIA)
  • 20% iShares S&P 500 Value Index ETF (IVE)
  • 20% iShares S&P 1000 Value Index ETF (IWD)
  • 15% iShares Russell 2000 Value Index ETF (IWN)
  • 15% iShares Russell Midcap Value Index ETF (IWS)
  • 20% Vanguard Total Stock Market ETF (VTI)

For Treasury bonds, you get

  • 50% iShares Barclays 1-3 Year Treasury Bond Fund (SHY)
  • 50% iShares Barclays TIPS Bond Fund (TIP).

So the stocks and bonds you get will give you a nice diversified portfolio that will for the most part track index performance across various sectors.

Forecasting And Visualization Tools

One of the cool things in the Betterment account are the allocation and visualization tools that they have available. The tools make it easy for the average investor to see what kind of returns they might see (given historical returns)  if they invest with a 5, 10, 20 or even 30 year time horizon.   Once you come up with an allocation and time horizon that you are comfortable with, just hit the button to change your allocation, and within a few days your changes are made!  Check out their online demo here: (demo).

Let’s say that you have about $50,000 invested as the demo account does.   If you have 80% invested in stocks and 20% in bonds, given a 20 year time horizon it will show you a forecasted range of returns that you could expect to see – anywhere from $100,000-$600,000.  Change the percentages and time-line and it can drastically affect your results.  It's interesting to look at just how drastically things can changed based on the decisions you make.

So if you decide you want to change your allocation either to include more stocks or bonds, you just move the slider up or down, and then hit the “change” button, and Betterment will update your account holdings and purchasing decisions going forward.

Portfolio Out Of Whack? Automatic Re-allocation To The Rescue

One thing that often happens with traditional retirement accounts is that the account owner neglects to ever update his or her portfolio on a regular basis, and in the end their allocations get all out of whack.

One of the nice things about an account with Betterment is that you never have to re-allocate your money. It will automatically re-balance your portfolio for you every three months, or if your allocations ever drift more than 5% before that.  Without re-balancing your account can easily shift over time to have an allocation that is heavier on stocks or bonds than you want it to be. If you start out at say 90/10 stocks to bonds, if you don’t reallocate over time you could one day find that your account has an allocation more like 80/20 or 85/15.

This is one of those things that most investors neglect to do on a regular basis, so it’s nice to have that part of the account be automatic.

What Does It Cost?

What kind of fees can you expect to pay for using Betterment   Well first off, there are no minimums to invest, and there are no fees for trades.   The only fee Betterment charges is a pro-rated yearly fee that is in a range of 0.15% to 0.35%, depending on your account balance. For most beginning investors it will come out to .35% annually.

For starter accounts with a minimum balance of $0 and $100/month minimum deposit, you'll have a .35% annual fee.  Minimum balance of $10,000?   You'll get next day transfers and a  .25% annual fee.  Minimum balance of $100,000?   You'll get next day transfers and custom portfolio options along with a low .15% annual fee.

For an account where you'll be having someone manage your investments for you, re-allocating their portfolio every so often, and not having to worry about ever paying any other fees or charges for making trades – these are some pretty reasonable fees.  It makes the account a winner.   I think it definitely makes sense for most people.

I've Signed Up For Betterment

While I did have some reservations about the site back when they launched,  I went ahead and signed up for Betterment.com.  I'm gonna try it out for a while. One of the great things about the account is that it's more like a traditional bank account in that getting your money in and out of the account is as simple as withdrawing it. No fees associated with making trades. The only risk you take is the same risk that any investment in equities has.   Add to that they've got a account signup bonus now as well, and you've got nothing to lose. So why not try it out?

Personally I just really love the idea of making investing that much more simple as it will make it more accessible for a ton of other folks.  So we'll see how it goes – I'll probably report back in a while to give a rundown of what I think of the site after I've actually been investing – and playing with their tools for a couple of months.

Get a bonus when you open your Betterment account. Click here.

 Get StartedWith Betterment

When Is The IRA Contribution And Recharacterization Deadline?

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I‘ve written quite a bit on this site about how I believe everyone should open and fund an IRA, whether it's a Roth IRA or a Traditional IRA.  For a lot of folks it's one of those things that they just continually put off, and once it has hit the new year, they believe it's too late to contribute for the previous year, so they continue to procrastinate.  The problem is, that's not the case.

What a lot of people don't realize is that the deadline to open and contribute to an IRA or to recharacterize an IRA contribution is not the last day of the 2010 tax  year, but instead it's tax day.  This year that falls on April 18th, 2011.

IRA Contribution Deadline

As people start putting all of their tax documentation together it can be easy to forget about all the tasks that you can still perform for the 2010 tax year, even once it turns over to 2011.

Even if you haven't opened an IRA prior to 12/31/2010, you can still open one in 2011 before tax day, and contribute to it for the 2010 tax year.  That applies to both the Traditional and Roth IRA.  So there's no excuse not to open one – it isn't too late!

Add to that the fact that you have 3 extra days this year to open an account and contribute, and it should be a lock.  April 15th, which is usually tax day, falls on a federal holiday this year – Emancipation Day – which is observed in DC.   Holidays impact tax deadlines for everyone, so this year the tax filing deadline is April 18th.

IRA Recharacterization Deadline

Sometimes people will make a contribution to their retirement account, and later on they'll decide that they want to recharacterize the contribution so that it is in a different type of IRA (traditional vs. Roth).    Some of the reasons why you might do this include:

  • Your income exceeds certain limits: Sometimes you may plan on meeting an income limit for your taxes, but when you make a contribution or conversion to your IRA, it bumps you over the limit. This happens sometimes when receiving a substantial bonus at the end of the year.
  • Your situation changed: Since you contributed you have realized that a Roth IRA (or traditional) would be better for your situation.
  • You need to lower your AGI (adjusted gross income): Sometimes certain tax credits or deductions are only eligible to folks in certain income levels.  You can lower your taxable income by recharacterizing.

Whatever the reason for your recharacterization, There are a few steps you must perform by the deadline on tax day, April 18th.  You must complete a transfer, and report the recharacterization on your taxes (Form 8606).

Are you putting off performing either of these tasks?  Has your procrastination caused you to miss the deadline in past years?  Tell us your thoughts in the comments.

Are You Sacrificing Your Retirement?

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Many of us don't realize that we're sacrificing retirement. Indeed, we are often unaware that some of the choices we make now can have far-reaching consequences that can put retirement at risk. Whether you are trying to create an income stream that can help you with your retirement expenses, or whether you have a target number for your nest egg, you need to watch out for behaviors that can sacrifice your long-term prosperity during your retirement years.

Raiding Your Retirement Account

One of the most obvious ways that you might be sacrificing your retirement is by raiding your fund. Tax-advantaged IRAs and 401ks sit there, beckoning, full of cash. You might tell yourself that you will replace the money, since you are only getting a loan, but many people don't actually put the money back.

If you don't put the money back, you end up paying penalties and taxes. Even if you do actually “pay yourself back,” the fact of the matter is that you have removed some of your capital from the account. You miss out on earnings that you could have had if your retirement account hadn't been missing funds for those months.

Saving Less Than You Should

Another way you might be sacrificing your retirement is by saving less than you should. Sure, it is important to enjoy yourself now. But without planning your spending, you might find that you have frittered away your tomorrow for things that you regret getting today. Do what you can to save as much as possible in retirement accounts. If you set aside $300 a month for 20 years, and earned 6% interest, the Money Chimp compound interest calculator says that you would have $141,335.96. Put $200 more in a month, you end up with $235,559.93. That's a pretty substantial difference.

Consider, too, what you could be missing out on if you aren't maxing out your tax-advantaged retirement accounts before you open a brokerage account. You will lose money to the government if you aren't fully using the savings resources available to you.

It is also possible to sacrifice your retirement when you don't think about what you could be doing to diversify your income. If you have maxed out your retirement accounts, it is possible to begin investing your money in a way that can build up other income streams. Invest in dividend paying stocks, consider investing in yourself by starting a business, or look for some other way to use your money to make more money.

Inflation: The Hidden Enemy

You might be sacrificing your retirement by not paying attention to inflation. Inflation erodes your purchasing power. $1 million in 20 years won't buy you as much as $1 million does today. Just think about what you could get with $1 even 10 years ago. You'd be hard-pressed to get that same value today. When planning for retirement, it is important to take into account the ravages of inflation.

Make sure that you factor inflation into your plans; you might end up meeting your target, but the money might not last as long since you will need more of it to meet your lifestyle requirements. Consider diversifying to include a mix of investments that can help you offset the effects of inflation.

What other ways might you be sacrificing your retirement?