Q: My wife and I are 54 years old and we still have about 94% of our retirement savings in a variety of stock mutual funds and ETFs. Should I begin moving some of that to bond funds? — Gary Wirth, Pittsburgh
A: Assuming you and your wife are still more than a decade away from retirement, you’ll want to keep the bulk of your investments in stock funds and ETFs.
Even so, your 94% allocation to equities is on the high side at this stage of the game, says Mitch Tuchman, managing director of Rebalance IRA, a national independent investment advisory service that specializes in asset allocation.
At this point, while you’re still working and accumulating savings, adding bonds to your portfolio isn’t as much about earning income as it is giving your investments some ballast in case the stock market goes topsy turvy — as it did briefly in late September and early October.
The question then isn’t if you need some additional bond exposure, but how much more?
Most experts, including Tuchman, do not recommend relying on the old rule of thumb that says the percentage of your portfolio in fixed income should equal your age. According to that old standard, 54-year-olds ought to keep 54% of their portfolios in bonds while holding a minority of their money in equities.
That rule doesn’t apply for a couple of reasons, says Tuchman. First, people are working longer and living longer. Second, you have to consider the environment you’re in. With bond yields as low as they are, for as long as they’ve been, there is a real risk interest rates will go up.
Why is that bad?
Market interest rates move in the opposite direction of bond prices. When rates rise, prices on existing bonds in a portfolio will likely go down. In theory, this means you could lose money in bonds when this shift takes place.
Your target allocation to bonds will also depend on other factors, such as how long you and your wife plan to keep working and your emotional tolerance for market swings. If you lose sleep and make rash choices (i.e. move to cash) when the market dips, you should probably own a larger helping of bonds.
With all that said, Tuchman suggests a good target for you and your wife is about 15% in bonds. He recommends divvying that up among high-quality corporate bond funds, high-yield funds, and emerging market debt funds. “Those groups still pay a reasonable amount of interest and, for various reasons, are a better hedge in a rising rate environment,” he says.
Having 15% of your portfolio in bonds may still seem like an aggressive stance.
Keep in mind, though, that Tuchman is not saying that the rest of your investments belong in equities.
In addition to the bond holdings, Tuchman says it’s also a good idea to allocate 5% to 10% of your total portfolio to real estate — in the form of real estate investment trusts — and another 5% to 10% to dividend-paying stocks, which are considered more conservative than other types of equities.
As for the remaining 70% or so of your portfolio, make sure that’s well diversified among large-cap stocks, small-cap U.S. shares, foreign equities, and emerging-market stocks.
This mix should get you through the next several years, says Tuchman, who at 58 adheres to a similar strategy in his own portfolio.
Read more on asset allocation:
Q: I owe my handiness to projects I helped my father with as a kid. But my children show no interest in lifting a hammer. How do I motivate them to become capable do-it-themselfers?
A: Thanks to affluenza as well as the draw of computer-based learning, instead of hands-on tutorials, many of today’s young digital natives are sorely lacking in analog skills. We are creating a generation that may never know how to paint a straight line or re-shingle a shed.
The effects are twofold. First, your kids may grow up into adults who, for every household project, are at the mercy of those few capable peers who become handymen and contractors. They’ll pay every time they need to tighten a rattling window or fix the toilet.
Also this lack of hands-on knowledge is—ironically—a contributing factor as to why other countries are outcompeting the United States in science, technology, engineering, and math education, those so-called STEM subjects where many of the good jobs of the future promise to be.
Getting your kids involved with you in safe, age-appropriate DIY projects is a great way to bolster their “spatial awareness,” an understanding of 3D space and how things work that helps later with engineering and physics, according to Vanderbilt University psychologist David Lubinski.
Thus spending a few hours away from their screens helping you build garage shelves or plant flower bulbs can give your kids a leg up on a career in the very technology they love.
Of course, as any parent knows, telling them that may not be enough to motivate them. Yet don’t resort to bribing your kids with a trip to Five Guys or extra screen time to get them to help out, says Carol S. Dweck, a psychology professor at Stanford University. That sends the message that the job is an unpleasant one that no child in her right mind would want to do.
You’re better off channeling Tom Sawyer and making the project feel fun and interesting. It helps if you pick an exciting improvement task, such as building a fire-pit, hanging cabinets in the recreation room, or painting the kid’s own bedroom in her choice of color (perhaps from a list preselected by you), rather than a maintenance job like snaking a drain or bleeding the radiators. Older youth may be enticed by the chance to use power tools (with plenty of knowledgeable and safe parental supervision).
Projects with relatively immediate gratification, like painting or laying sod, are more inspiring for young minds. Thus make it a project that they’ll get to enjoy the results of—and do it at a time when distractions like video games and social networking are off limits anyway. Then, let her post photos of the finished work on Facebook, if she wants, to help build her pride and a sense of accomplishment in her work.
Got a question for Josh? We’d love to hear it. Please send submissions to firstname.lastname@example.org.
Q: I am maxing out my 401(k). I understand there’s a new way to make after-tax contributions to a Roth IRA. How does that work?
A: You can thank the IRS for what is essentially a huge tax break for higher-income retirement savers, especially folks like yourself who are already maxing out contributions to tax-sheltered retirement plans.
A recent ruling by the IRS allows eligible workers to easily move after-tax contributions from their 401(k) or 403(b) plan to Roth IRAs when they exit their company plan. “With this new ruling, retirement savers are getting a huge increase in their ability contribute to a Roth IRA,” says Brian Holmes, president and CEO of investment advisory firm Signature Estate and Investment Advisors.
The Roth is a valuable income stream in retirement because contributions are after-tax, which means you don’t owe Uncle Sam anything on the money you withdraw. Unlike traditional IRAs which require you to start withdrawing money once you turn 70 ½, Roths have no mandatory distribution requirements, so your investments can continue to grow tax-free. And if you need to take a chunk out for a sudden big expense, such as medical bills, the withdrawal won’t bump you up into a higher tax bracket.
For high-income earners, the IRS ruling is especially good news. Singles with an adjusted gross income of $129,000 or more can’t directly contribute to a Roth IRA; for married couples, the income cap is $191,000. If you are are eligible to contribute to a Roth IRA, you can’t contribute more than $5,500 this year or next ($6,500 for people over 50). The IRS does allow people to convert traditional IRAs to Roth IRAs but you must pay income tax on your gains.
Now, with this new IRS ruling, you can put a lot more into a Roth by diverting your 401(k) assets into one. The annual limit on pre-tax contributions to 401(k) plans is $17,500 and $23,000 for people over 50; those limits rise to $18,000 and $24,000 next year. Including your pre-tax and post-tax contributions, as well as pre-tax employer matches, the total amount a worker can save in 401(k) and 403(b) plans is $52,000 and $57,500 for those 50 and older. (That amount will rise to $53,000 and $59,000 respectively in 2015.) When you leave your employer, you can separate the after-tax money and send it directly to a Roth, which can boost your tax-free savings by tens of thousands of dollars.
To take advantage of the new rule, your employer plan must allow after-tax contributions to your 401(k). About 53% of 401(k) plans allow both pre-tax and after- tax contributions, according to Rick Meigs, president of the 401(k) Help Center. You must also first max out your pre-tax contributions. The transfer to a Roth must be done at the same time you roll your existing 401(k)’s pre-tax savings into a traditional IRA.
The ability to put away more in a Roth is also good for people who want to leave money to heirs. Inherited Roth IRAs are free of tax, and because they don’t have taxable minimum required distributions, they can give your heirs decades of tax-free growth. “It’s absolutely the best asset to die with if you want to leave money behind,” says Holmes.
Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.
Brad Katsuyama, CEO of IEX, talks about why he helped to build a startup stock exchange.+ READ ARTICLE
Q: I received some shares of stock some years ago that were given to me as part of an agreement through a class-action lawsuit. Do I have to pay taxes on these shares when I sell? — Bob from Livingston, Tex.
A: In most instances, you would, says Michael Eisenberg, a certified public accountant in Los Angeles.
When you receive stock in lieu of cash for payment for services rendered or, in this case, a settlement, you’ll first owe income tax based on the value of the stock at that time. “Compensation is compensation, whether it’s cash or stock,” says Eisenberg. “It’s considered ordinary income.”
If you later sell the stock for a profit, you’ll also owe capital gains tax. How much you owe is based on the difference in value from the time you received the stock and the time you sold it, after accounting for such things as dividends, stock splits or capital distributions. This is called “basis.”
If you own the stock for less than 366 days – one year plus a day – your capital gains rate will be based on your income tax rate. If you own it longer, you’ll pay a lower rate.
Taxpayers in most brackets are taxed at 15% for long-term gains. Those in the 10% or 15% bracket may owe no long-term capital gains tax, while those in the 39.6% rate will need to pay up at 20%.
Are there any exceptions?
If for some reason this stock was given to you as a result of a class-action related to your retirement account, you may not owe tax. “If the stock settlement was applied to your IRA, it wouldn’t be taxable,” says Eisenberg, though such an example is pretty rare.
What if you receive stock as a gift or an inheritance?
In this case, you won’t owe income tax on that gift. You will, however, still owe capital gains tax when you sell.
If the stock is part of an inheritance, your capital gains rate will be based on the value of the stock at the time the original owner passed away. If your Granny gifts you stock while she’s still alive, however, your basis is based on when she bought the stock.
Ritholtz Wealth Management CEO Josh Brown, a.k.a. the Reformed Broker, explains the relationship between media coverage and financial bubbles.+ READ ARTICLE
Q: Are there professional administrator services for private wills? I’m single with no family or appropriate friends. – Paul, Calif.
A: Everyone needs a person or institution to act as executor and administer the estate though the probate process.
Because your executor will be in charge of collecting the estate’s assets, inventorying the property, paying claims against the estate (including taxes), and distributing assets to beneficiaries, you want to give the job to someone who is financially responsible and trustworthy.
That could be someone you know, say a relative or close friend, but it can also be an institution, or what you referred to as a professional will administrator.
Because of the complexity involved, many individual executors have to hire professionals to help. So even if you do have someone close to you take on the role, having a reliable and impartial professional as backup would be smart.
How to find the right pro
You could name your lawyer, accountant, or financial adviser as your executor, but Greg Sellers, a certified public accountant and president of the National Association of Estate Planners and Councils, warns against it, no matter how good a working relationship you already have.
“If your executor is also the one drafting your estate planning documents, there is the opportunity for them to do some self-dealing,” says Sellers. “While they may be legally bound to carry out your wishes, it presents a chance for conflicting interests. They could have undue influence on the documents, could charge higher than normal fees.” And acting as an executor may not be in the normal scope of what your accountant and financial adviser do.
Sellers recommends using a corporate trust company, either one affiliated with a financial institution like your bank or full-service brokerage, or an independent trust company. These companies have teams that manage estates full time. You don’t need a trust to use a trust company; they take on jobs just handling will administration.
What a pro will charge
Of course, hiring a professional will mean paying a fee (leaving a little less for your heirs). Some states set maximums that an executor can charge, but Sellers says that except in rare circumstances, executor fees should not go above 5% of the value of the estate.
The fee will likely land on the high end of the scale if your estate has lots of moving parts, such as a small business, personal property that needs to be sold, or investment accounts in more than one place. The total value of your assets matters too: the larger the estate, the smaller the percentage a professional executor will deduct.
This one-time fee will be paid from your estate after your death and is typically non-negotiable, Sellers says. While companies are upfront about the likely fees, they will not settle on an amount until they find out exactly what being executor involves, which can’t be known until your death.
Once you’ve settled on a company to be you executor, Sellers recommends letting it know and sending a copy of your will (though it isn’t necessary—you can simply note who you picked in your will).
Any company has the right to reject the job, which is why Sellers recommends naming a backup. If both your first and second choices reject the job, the probate court will assign an executor.
Q: I have an $800,000 portfolio. How many mutual funds should I own? — Lynn
A: The optimal number of funds will vary depending on your time horizon, tolerance for risk, and exactly what kinds of funds you choose.
That said, if you’re looking to build and manage a diversified portfolio of exchange-traded funds (ETFs) or index mutual funds on your own, a good number is either six or 10, says Bill Valentine, president of Valentine Ventures, a Bend, Ore.-based wealth management firm. This is true, he says, whether you have $800,000 or a more modest portfolio.
Anything more than that many funds will “do nothing for diversification,” Valentine says, and will only add cost and complexity to your strategy.
Let’s start by discussing the whole notion of diversification. To get the best balance of risk and reward, you’ll want to invest in lots of securities across many different asset classes. Investing in ETFs or index mutual funds takes care of the first critical point of diversification since most such funds are composed of hundreds of different securities.
Even so, a single fund focused on a single asset class won’t provide you adequate diversification. Likewise, investing in six funds that all hold, say, large blue chip U.S. companies won’t improve returns, and may even detract from them.
“It’s important to blend asset classes than don’t act too similarly to each other, otherwise you’ll lose the benefit of diversification,” says Valentine.
If you’re young and have a long time horizon, you may not own bonds in your portfolio. Valentine says you’ll still want to spread your bets across six primary investment classes.
They include U.S. large cap stocks, U.S. small cap stocks, foreign developed-market stocks (shares of companies based in Europe and Japan), and foreign emerging-market stocks (shares of companies based in faster-growing economies such as like China and India).
And to diversify your equities, you’ll also want to consider owning a small amount in commodities and real estate investment trusts, or REITs.
Exactly how you slice the pie will depend on your specific time horizon and risk tolerance. Note: Valentine is not a proponent of owning bonds if you’re young, but most advisers recommend a small allocation to fixed income, even in a relatively aggressive portfolio.
Now, if you own bonds as part of your mix, you may want to add as many as four fixed-income funds to that mix.
Valentine recommends bond funds that give you exposure to: the broad U.S. fixed-income market (reflecting high-quality corporate and government debt), U.S. high yield bonds (which expose you to higher-yielding but lower-quality corporate debt), U.S. inflation-protected securities (to safeguard your holdings against rising consumer prices), and foreign bonds.
Again, the exact percentages will vary based on the specifics of your situation.
Q: When remodeling my house, I don’t want to spend a lot of money on updates that don’t actually increase my home value. How do I know how much is a smart amount amount to invest, and when I would be going overboard?
A: Jump into a renovation project without first setting a budget and you may spend loads of cash on all sorts of lovely options—from a marble island-top for your kitchen to a two-person hot tub for your new patio—that you won’t get paid back for if you sell your house in a few years.
While that may not be a concern if you’re staying put for the long haul, if you’re likely to move in 10 years or less, it pays to limit your spending to what you might reasonably hope to get back at resale.
Thus start with renovating only spaces that are functionally obsolete, says Omaha, Nebraska, appraiser John Bredemeyer, a spokesman for the Appraisal Institute, a trade association. “Changing out a perfectly good, 10-year-old kitchen, for example, just because you don’t like the previous owner’s style choices, is not an investment that will pay you back at resale,” he says. But if that kitchen is from the 1940s, 1960s, or even the 1970s, a well-budgeted renovation makes financial sense.
How much should you invest? Bredemeyer’s rule of thumb is to spend no more on each room than the value of that room as a percentage of your overall house value (you can find an approximate value of your home at zillow.com).
Here’s how the percentages break down for each room:
Kitchen: 10% to 15% of house’s value
Kitchen renovation budget for a:
$300,000 house: $30,000 to $45,000
$500,000 house: $50,000 to $75,000
$750,000 house: $75,000 to $112,500
Master Bathroom Suite: 10% of house’s value
Master bathroom suite renovation budget for a:
$300,000 house: $30,000
$500,000 house: $50,000
$750,000 house: $75,000
Powder Room/Bathroom: 5% of house’s value
Powder room/bathroom renovation budget for a:
$300,000 house: $15,000
$500,000 house: $25,000
$750,000 house: $37,500
Finished Attic or Basement: 10% to 15% of house’s value
Attic or basement finishing budget for a:
$300,000 house: $30,000 to $45,000
$500,000 house: $50,000 to $75,000
$750,000 house: $75,000 to $112,500
Other Rooms: 1% to 3% of house’s value
Living room, dining room, or bedroom renovation budget for a:
$300,000 house: $3,000 to $9,000
$500,000 house: $5,000 to $15,000
$750,000 house: $7,500 to $22,500
Patio, Deck, Paths, and Plantings: 2% to 5% of house’s value
$300,000 house: $6,000 to $15,000
$500,000 house: $10,000 to $25,000
$750,000 house: $15,000 to $37,500
Got a question for Josh? We’d love to hear it. Please send submissions to email@example.com.