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Fund tips to help you act your investment age

July 19, 2004

There are many factors to consider when you start investing – such as what to invest in and how much it will cost. But what many people might not realize is that one of the most important considerations is your age.

How old you are determines how long you have to invest, and that can help decide how much investment risk you should take.

Ryan Hughes of pension provider AJ Bell says: ‘The rule of thumb is that the longer timeframe you have the more risk you can afford to take.

‘But, of course, you should never take more risk than you are comfortable with. There is no point investing in a way that will give you sleepless nights.’

Starting Early

Beginning as young as possible can give you a head start. For many people, the investment journey may begin as a child. Parents and grandparents can squirrel away up to £4,128 a year tax-free for children through a Junior Isa.

Not only will starting early give the investment pot longer to grow, it can also get youngsters into a good savings habit for later life. Grandparents who invest £50 a month into a Junior Isa from a child’s birth could see the investment grow to more than £17,500 by age 18 if it grew at 5 per cent a year.

The younger you are, the more risk you can afford to take – for if there is a stock market crash there is more time for your money to recover.

Hughes says of savers starting in their 20s: ‘Investing for retirement could involve someone investing for 40 years, so higher-risk investments such as emerging markets and technology stocks could be appropriate.’

He suggests Fidelity Index World as a core investment choice for a young person’s portfolio. The fund is a cheap way to invest in stock markets worldwide and has returned 47 per cent over the past three years.

He also likes fund Invesco Perpetual Asian which focuses on companies based in China, South Korea and Hong Kong, such as electronics firm Samsung and internet specialist Baidu. It has returned 68 per cent over three years.

A racier choice is Polar Capital Technology fund, which aims to tap into key technology trends. It invests in internet giants such as Amazon and Facebook, plus lesser-known outfits with growth potential such as semiconductor maker Advanced Micro Devices.

The fund has returned 100 per cent over three years.

Rob Morgan, investment analyst at Charles Stanley, likes Franklin UK Smaller Companies fund. He says: ‘Investors sometimes overlook smaller companies. But they tend to be more dynamic and quick to react to growth opportunities.’

The fund, which has returned 45 per cent over three years, aims to find fast-growing companies.

The manager likes software companies and support services firms such as Clipper Logistics and shipping company Clarkson.

Mid-life Money Management

When you reach your 40s, it is time to start taking a more conservative approach.

As you get closer to retirement you may want to start being more cautious and reducing the proportion of your portfolio which is equity-based.

Michael Martin of investment house Seven Investment Management likes Troy Trojan fund as an ‘all-weather option’.

The fund, which has returned 22 per cent over three years, invests in a mix of company shares, government bonds and gold. This should mean the fund offers steady growth regardless of what the economy is doing.

He also likes Fundsmith Equity fund, run by veteran City investor Terry Smith. His strategy is to invest in companies which are so successful you never need to sell the shares.

The fund favors firms with strong brands such as Pepsico and Microsoft – with two-thirds of its money in US firms. It has returned 87 per cent in the past three years.

Another favorite is Lindsell Train Global Equity fund which invests in ‘boring’ firms renowned for paying a good income.

Income Focus

An increasing number of people keep their money invested even after they stop working. But investment choices should be cautious and focus on paying an income. Hughes says: ‘Generating income is vital. A good quality equity income fund can fulfill this purpose.

He likes Evenlode Income fund, which currently yields 3.4 per cent. The fund invests in firms such as Johnson & Johnson and AstraZeneca, which consistently grow their dividends.

Another favorite is Newton Global Income which invests in dividend-paying firm across the globe. It has a focus on larger businesses such as Microsoft and Unilever and currently yields 3.2 per cent.

A fixed income fund is a sensible choice for income. These invest in government and company bonds. Henderson Fixed Interest Monthly Income invests in the debt of companies including Barclays and Nationwide Building Society.

One-Stop Shop Choices

For many investors, the idea of picking their own investment funds can be daunting. There are now some 2,500 funds available through fund supermarkets such as Fidelity and Hargreaves Lansdown.

Deciding which ones are right can prove challenging. Multi-asset funds are a good one-stop solution.

Charles Stanley’s Morgan says: ‘Multi-asset funds invest across different areas, mixing shares and bonds as well as alternative assets such as property. The result is a diverse portfolio in a single fund, which is helpful for those looking for a low-maintenance investment choice.’

He likes Investec Diversified Income fund as an ‘uncomplicated, conservatively-run’ choice.

Another strategy is to pick a multi-manager fund. These invest in other funds using their expertise to find the best mixture of fund managers to generate returns.

Seven’s Martin likes Jupiter Merlin Balanced which invests in funds such as Woodford Equity Income and Fundsmith Equity.

How to Make Sure Your Money Lasts Through Your Retirement

July 9, 2004

The S&P 500 didn't gain ground in 2015, so neither did retiree Bruce Stanton's spending money. That summer, the former teacher in Washougal, Wash., dialed back what he withdrew from his retirement account to reflect the lackluster market. Fluctuations in income aren't that rare. During his career as a chemistry teacher, Stanton would sometimes get a big raise and other times get none. "I'm used to going without them," says Stanton, 63.

A challenge for all retirees is creating an income stream that will last a lifetime even if a downturn takes a big bite out of their savings. Some, like Stanton, are tackling this by adjusting withdrawals based on the market's performance.

But market-linked approaches run counter to the long-standing 4% rule, which holds that your money will last for a 30-year retirement if you withdraw 4% of your nest egg the first year and adjust that dollar amount annually for inflation.

Some experts are now arguing for a lower initial rate—such as 3%—since stocks and bonds may deliver below-average returns over the next few decades. Yet for much of history, 4% has been conservative, according to financial adviser Michael Kitces.

So what's a retiree to do? As an alternative to withdrawing a fixed percentage, here's a look at four "dynamic" withdrawal strategies.

Skip rises in down years.

Under the 4% rule, retirees with $1 million would take out $40,000 in the first year. Then they'd typically boost that dollar amount in subsequent years based on the consumer price index (CPI), a common gauge of inflation. So if CPI rises 2%, they'd take out $40,800 in year two.

But to play it safer, you could choose to skip those raises in years following negative returns for your portfolio.

David Blanchett, Morningstar's head of retirement research, says if you skip the inflation bump in down years, the chances your money will last until age 90 will go up by nearly 11 percentage points, assuming an initial 4% withdrawal.

Ratchet higher in up years.

What if you care about flexibility, but instead of sacrificing after down years, you want to reap the rewards of a strong market?

Kitces says if your account ever grows 50% above its starting value after initiating withdrawals—says you retired with $1 million but your balance rises to $1.5 million—you can go ahead and boost your withdrawals by an additional 10% above any inflation adjustments in perpetuity. Assuming you were going to withdraw $45,000 this year, you'd actually be able to tap as much as $49,500. And you wouldn't have to slash withdrawals after subsequent downturns.

According to Kitces, this strategy won't deplete your account under any scenario. The higher spending, though, makes this less than ideal if you want to leave legacies to your heirs.

Set a floor and a ceiling.

This hybrid approach, pioneered by Vanguard, starts out by establishing an annual rate of withdrawals—say, 4%. Then you set a ceiling that's no more than 5% higher than the prior year's income level, and a floor that's no more than 2.5% lower.

Here's how that would work: Assume you start with $1 million, and say you plan to withdraw 4%, or $40,000, at year's end. But market forces boost the value of your nest egg by 20% to $1.2 million. How much would you be able to tap at the end of year two? Well, you'd start by applying that 4% rate again to your new balance, which comes to $48,000. Then you'd see if that amount falls within your ceiling and floor. In this case, a 5% ceiling on $40,000 would be $42,000, which is below the $48,000 mark—so you'd go with the lower figure.

This ceiling-and-floor approach had a 92% success rate, meaning in more than nine out of 10 possible scenarios, retirement funds aren't depleted even after 35 years, according to Vanguard. By contrast, the traditional 4% rule with annual inflation adjustments resulted in a 78% success rate.

This also mimics human behavior: People tend to splurge when the market is up, and dial back when it's down, says Francis Kinniry, a principal in Vanguard Investment Strategy Group.

Use RMDs as your guide.

Once you reach age 70½, you have to take required minimum distributions (RMDs) from your traditional IRAs. Its Uncle Sam's way of getting his hands on money that's been tax sheltered for years.

To calculate your RMD, you divide your IRA balance by an IRS-provided figure that represents an actuarial estimate of the remaining life span of someone your age. At 70, your denominator is 27.4; meaning that under certain circumstances someone your age may live until nearly 97½.

As it happens, you can "take advantage of the actuarial strategy behind RMDs to guide your spending," says Wade Pfau, professor of retirement income at the American College of Financial Services. No one under 70½ must take RMDs, but there are equivalent lifetime expectancy figures. For a 65 year old, it's 31.9.

If you retire at 65, you'd divide your nest egg by 31.9. With a $1 million account, that's $31,350, meaning rather than tapping 4% of your nest egg, you'd be taking 3.1%, a relatively conservative approach.

Investors who aren't looking to leave a lot in their accounts for heirs might alter the formula slightly to boost their income.

For instance, you might modify your RMD amount by a factor of 1.1. Here, you'd multiply that $31,350 figure by 1.1, and at 65 you could withdraw close to $34,500 on that $1 million account.

8 spending habits that eclipse your savings

June 29, 2004

spending habits that eclipse your savingsPoor spending habits can snuff out your savings, just like the moon snuffs out the sun in a solar eclipse. The sun comes back out, but will your savings?

Today many of us in the US got a celestial treat: the first total solar eclipse in nearly a century. At the place where I work there is a high concentration of technical people, so we were all geeking out outside and enjoying the show, complete with pinhole cameras, polarizing sheets, colanders, and eclipse glasses.

Spending habits can be the difference between night and day

Just like the moon covers up the light of the sun, poor spending habits can cover up your savings, and then some.

Spending less than you earn is what responsible personal finance boils down to. Nothing else is sustainable in the long run.

Here are eight spending habits that are best to avoid if you want to save money and have good personal finance:

  • Large student loans. A college degree is an income-booster, generally. There are also insanely expensive ways to go to college, just as there are cheap ways to go to college. Coming out of college with a load of student loans — which, by the way, are notoriously difficult to get discharged — can substantially cut into your ability to save for years. (Or, even worse, failing out of college with debt. Ouch!)
     
  • Lavish, over-the-top weddings. Having gone through a wedding myself, I fully understand the desire to have a great day. It should be an once-in-a-lifetime event (kind of like a really good solar eclipse). At the end of it all, though, you'll be just as completely married after a $3,000 wedding as you will after a $50,000 wedding. The only difference is the bill. And if it comes with a five-figure credit card debt afterwards — well, the honeymoon will be over more quickly than you realize. Opt for a budget wedding and you'll be happy you did (and your guests probably won't think any less of you, either).
     
  • Buying as much house as the bank will approve you for. When I was getting our loan approval for our current house, I was flabbergasted by how much they would lend me. If I remember, it was an amount that would result in a mortgage payment of nearly half of my take-home pay. That was way, way too much for me! But … the banks know that you'll move mountains to make that mortgage payment, so they don't really care too much if you are strained financially by it. Our mortgage payment is something more like 15% of our take-home pay. The less the better!
     
  • An addiction to new vehicles. Buying new vehicles is a nice luxury if you can afford them and pay cash, but borrowing for them is like throwing thousands of dollars down the drain. New vehicles lose 15% or more the second they're driven off of the lot, and there's basically no way to get that back, ever. Buying used cars has the advantage that the first owner paid the depreciation for you. They'll still go down in value, but not nearly to the extent that they did the first year. (Buying used is a great saving tips in general, too!)
     
  • Eating out all the time. Eating out once in a while for special occasions is a nice treat, but when it's one or two meals a day, every day of the week, it takes its toll on your bank account. Learn some simple meals that you can make yourself (here's my favorite soup for starters).
     
  • Mountains of credit card debt. I get it: Sometimes credit card debt is unavoidable. Stuff happens beyond people's control: a serious accident, or a serious illness, or both. But a lot of it is completely and utterly avoidable with some good spending habits and some self-restraint. Simply don't buy stuff that you can't afford.
     
  • Crazy-expensive vacations. Though it's unwise to cheap out too much on a vacation, it's equally unwise to vacation beyond your means. The vacation hangover is usually bad enough without a giant bill or humongous credit card balance to pay off.
     
  • Expensive toys with lots of maintenance. Think boat (which is an acronym for Bring on another Thousand), or a swimming pool, or a vacation home, or a time share. These toys have a lot of fees and maintenance costs that are ongoing; buying the toy is just the down payment.

12 Strategies to Generate Income in Retirement

June 16, 2004

When it comes to saving for retirement, maybe you've done everything right. You started early, maxed out your 401(k) plan, invested in a diversified portfolio and avoided costly mistakes, such as cashing out your retirement plan. Fantastic. But now comes the hard part: making sure you don't outlive your money.

That's a tall order for today's retirees. Taxes, unpredictable investment returns, rising health care costs and inflation down the road can significantly erode the value of your nest egg. And perhaps the biggest challenge is that you'll probably need the money for a long time. A 65-year-old man has a life expectancy of 19.3 years; it's 21.6 years for a 65-year-old woman. If you're married, there's a 45% chance that one of you will live to age 90 and a nearly 20% chance that you or your spouse will live to 95.

Fortunately, there are steps you can take to generate extra income and extend the life of your portfolio.

1. Put Your Money in Buckets

A bear market just as you enter retirement couldn't come at a worse time if you're forced to sell securities after prices have plunged. Certainly, many investors today worry about how long the bull market can keep running (see When Will the Bull Market End?). That's where the "bucket system" can help. Basically, you divide your money among different kinds of investments based on when you'll need it. Jason L. Smith, a financial adviser in West Lake, Ohio, and author of The Bucket Plan (Greenleaf Book Group Press), uses the system with clients, splitting their assets among three buckets: "Now," "Soon" and "Later."

The Now bucket holds what you'll need in the short term. Smith recommends setting aside enough so that, when added to Social Security or a pension, it will cover your basic expenses for up to a year. It should also have enough for major expenses that are likely to crop up over the next couple of years, such as paying for a new roof or that once-in-a-lifetime trip around the world, plus cash for unexpected emergencies.

Money in the Soon bucket will be your source of income for the next 10 years. Smith recommends investing in a fixed annuity (not an immediate annuity, which locks you into monthly payments) or high-quality short-term bonds or bond funds. As the Now bucket is depleted, you withdraw money from the annuity or sell some of the fixed-income investments in the Soon bucket to replenish it.

The assets in the Later bucket aren't meant to be tapped for more than a decade into your retirement, so they may be invested more aggressively in stock funds, which provide greater growth potential, and alternative investments such as REITs. This bucket can also include life insurance or a deferred-income annuity, which pays income later in life. Consider selling securities in the later bucket to replenish the Soon bucket starting about five years before it runs out of money. If the market is in a downward spiral, you can wait, knowing you still have a few years before the Soon bucket will be empty.

KIP TIP: Money you’ll need in the near term should be parked in a savings account. Yields on deposit accounts have been abysmal, and even though the Fed has been nudging rates higher, most banks haven’t passed on the increases to savers. Still, some are boosting rates. Yields on saving accounts requiring little or no minimum balance were recently 1.4% at Dollar Savings Direct, 1.35% at Live Oak Bank, and 1.3% at BankPurley and CIT Bank.

2. Manage Your Spending

To avoid running out of money during retirement, the standard rule has been to withdraw 4% from your nest egg in the first year of retirement and use the inflation rate as a guide to adjust withdrawals in subsequent years. For example, if you have $1 million, you can withdraw $40,000 in year one. If the inflation rate clocks in at 2% in year two, your withdrawal grows by 2%, to $40,800.

The 4% rule is based on historical market returns for a portfolio evenly split between stocks and bonds. But as the saying goes, past performance is no guarantee of future returns. Plus, the rule assumes you will live 30 years in retirement, so you might want to adjust the withdrawal rate up or down based on your life expectancy, says Judith Ward, a senior financial planner at T. Rowe Price.

Still, you should do just fine if you use the rule as a starting point for withdrawals. In fact, T. Rowe Price tested the 4% rule for a worker who retired in 2000 with a $500,000 portfolio (60% stocks, 40% bonds) and experienced two bear markets—the 47% drop in Standard & Poor’s 500-stock index in 2000–02 and the 55% drop in 2007–09. Though the retiree’s balance shrunk to about $300,000 by 2009—a 40% decline—the subsequent bull market helped restore the balance to $414,000 by the end of 2016.

KIP TIP: Like any rule of thumb, the 4% rule won’t work for everyone or in every situation. You might need to reduce the withdrawal rate if you retire early or have a major expense, or if a market downdraft wipes out a chunk of your nest egg. Or you might increase it if your investments have appreciated more than expected, or you’ve spent less than you anticipated and have built up a sizable balance.

3. Protect Against Inflation

The inflation rate has averaged 2.2% since 2000, and the Kiplinger forecast is for 1.3% inflation for 2017 and 1.9% for 2018. That seems tame, but don’t underestimate the power of even modest inflation, which can significantly erode purchasing power over time.

One way to make sure your nest egg keeps up with the cost of living is to remain invested in stocks. That can make for a bumpy ride over the short term, but over the long haul stocks’ steady upward trend makes them a go-to hedge against inflation. As measured by the S&P 500, stocks have returned an average annual rate of 10% for nine decades. Over the next decade, investors are more likely to see an average annual rate of 8% or even less—but even if inflation reverts to its long-term historical norm of a little over 3%, that return still provides a healthy cushion.

If you are near or just beginning retirement, advisers generally recommend a portfolio of up to 60% in stocks. But Michael Kitces, director of wealth management for Pinnacle Advisory Group in Columbia, Md., suggests that when stocks are highly valued (as they are now), investors should reduce their stock allocation to 30% at retirement. (If you’re using the bucket system, your 30% allocation to stocks goes in the later bucket.) You can gradually increase your portfolio’s stock holdings to 60% or whatever amount meets your comfort level, he says.

Treasury inflation-protected securities, or TIPS, are another hedge against rising consumer prices. With these bonds, issued by Uncle Sam, your principal will be adjusted for inflation. In addition, you’re guaranteed a fixed rate of interest every six months, so as the principal rises, so does the amount of interest you’ll earn.

Ease the tax bite by holding securities in the right accounts. Income from bonds and bond funds are taxed as ordinary income tax rates and are best held in a tax-deferred account, such as an IRA. Stocks get favorable tax treatment in a taxable account; most dividends from stocks and stock funds, as well as long-term capital gains, are taxed at only a 15% or 20% tax rate. But make sure you keep some stocks in tax-deferred accounts to fight the effects of inflation over the long term.

KIP TIP: You can buy TIPS straight from the federal government if you set up a TreasuryDirect account. That way, you won’t pay a commission to buy them, and you’ll avoid a management fee that comes with a TIPS fund. Plus, if you invest in TIPS directly, you’ll never get less than your original investment when the bonds reach maturity.

4. Get Income from Your Investments

If you need to boost your retirement paycheck to supplement Social Security and other sources of guaranteed income—or to generate cash while you wait for delayed benefits to supercharge your Social Security—dividend-paying stocks in a taxable portfolio should be high on your list. They can make up one-fourth to nearly one-half of your stock portfolio.

A number of blue-chip stocks have yields of 2.5% to 4%, including such stalwarts as Boeing (symbol BA), Caterpillar (CAT) and 3M (MMM). Look for companies with a record of regularly increasing dividends over time, which can serve as a hedge against inflation. But beware of chasing the highest yields. Outliers that boast yields of 7% or 8% may not generate enough profits to sustain those dividends.

As alternatives to individual stocks, consider exchange-traded funds and mutual funds that focus on investing in companies that pay dividends. T. Rowe Price Dividend Growth (PRDGX) and Vanguard Equity Income (VEIPX) are members of the Kiplinger 25, the list of our favorite mutual funds; Kiplinger’s 20 favorite ETFs include Schwab U.S. Dividend Equity (SCHD) and Vanguard High Dividend Yield (VYM).

Bonds are another key source of income. “You can make a huge difference in your income and your total return by properly managing the bond portion of your portfolio,” says Mari Adam, a certified financial planner with Adam Financial Associates, in Boca Raton, Fla.

The bond allocation for conservative investors near or at retirement is roughly 40% or more. Adam recommends that up to half of that be invested in a core bond or bond index fund consisting of U.S. government and high-quality corporate securities. Or, if you’re in the 28% or higher tax bracket, make municipal bonds your core holding, she says. The yields on munis issued by state and local governments tend to be lower than those of some other bonds, but you won’t owe federal taxes on the income.

Among mutual funds that focus on munis, Fidelity Intermediate Municipal Income (FLTMX) is in the Kip 25. The rest of the bond money can be spread among TIPS, high-yield bonds (also called junk bonds), international bonds, strategic bond funds, floating-rate bond funds and preferred stocks. (Preferreds behave like bonds, paying out regular fixed payments.)

KIP TIP: Real estate investment trusts, which own and manage properties such as offices, apartments and shopping malls, must distribute at least 90% of their taxable income to shareholders. Plus, REITs are a hedge against inflation. You can invest in REITs through ETFs and mutual funds. Among our favorites is Schwab U.S. REIT (SCHH).

5. Delay Social Security Benefits

You might not think of Social Security as an inflation fighter, but for many people it will be their only stream of income with an automatic cost-of-living adjustment. The COLA was only 0.3% for 2017, but it’s projected to be 2.2% in 2018. (When inflation was soaring in 1981, the COLA hit a record high of 14.3%.)

More than 45% of people take Social Security retirement benefits as early as they can, at age 62. For those who have taken early retirement, perhaps because of poor health, this often makes sense. But grabbing benefits early comes at a steep cost. If you claim Social Security at 62, your benefit will be reduced by as much as 30% compared with delaying until full retirement age (currently 66 but gradually rising to age 67). And if you’re patient and have other sources of income, you get a generous bonus for waiting until age 70 to claim benefits: For every year you wait to take Social Security beyond full retirement age until age 70, your benefit increases by 8%. Even better, future COLAs will be based on that bigger benefit.

KIP TIP: Spouses should coordinate their claiming strategies to maximize the survivor benefit. A married couple is likely to maximize lifetime income from Social Security if the higher earner delays taking Social Security until age 70, so no matter who dies first, the survivor gets the largest possible benefit (see How Misinformation from Social Security Can Cost You Tens of Thousands of Dollars).

6. Earn Extra Income

When Steve Cornelius retired in 2011 from his job as an executive for an industrial supply company in Atlanta, he moved to Minneapolis—no doubt passing other retirees who were headed in the opposite direction. “I can’t stand hot weather,” he says. Cornelius loves spending time outdoors and playing golf, but after a couple of years he realized he needed something else to do during Minnesota’s long, cold winters. His solution: a part-time job with tax-preparation giant H&R Block.

Cornelius, 67, started working for Block in 2013 and has a growing roster of return clients. His hours are flexible, but he usually works 32 hours a week from January through April. During the rest of the year, he works about 10 hours a week providing clients with general tax-planning advice.

Cornelius says the income from his job will allow him to postpone claiming Social Security benefits until he’s 70. He’ll get a bump up of 8% for every year he delays taking benefits after his full retirement age of 66. “That’s going to give me security against inflation, which will rear its ugly head at some point,” Cornelius says.

The income has also enabled Cornelius to take trips he might not otherwise be able to afford. This fall, he and his partner, Robin, are taking a cruise through Southeast Asia, with stops in Hanoi, Ho Chi Minh City, Bangkok and Singapore. “I’ve got a great retirement plan, but unless you’re Warren Buffett, you’re on a budget,” he says.

In addition to allowing you to delay taking Social Security, income from a part-time job can help cover your expenses during a market downturn, which means you won’t have to sell investments at a loss to pay the bills. Part-time and seasonal job opportunities run the gamut, from working as a park ranger to teaching English as a foreign language in another country. Freelancing is another way to earn extra cash (see www.freelancersunion.org for advice on everything from contracts to taxes). Freelance gigs range from online tutoring to consulting in your former profession. If you have a garage apartment or second home, you can earn income through home-sharing services, such as Airbnb.

KIP TIP: If you’re receiving Social Security benefits and haven’t reached full retirement age—66 for most retirees—be mindful of the earnings test. In 2017, if you make more than $16,920, you’ll lose $1 in benefits for every $2 you earn over that amount. In the year you reach full retirement age, you’ll give up $1 for every $3 you earn over $44,880 before your birthday. Starting in the month you reach full retirement age, you can earn as much as you want without worrying about the earnings test. But the benefits aren’t lost forever. Once you reach full retirement age, your benefits will be adjusted to recover what was withheld. Still, if you’re planning on working after you retire, it makes sense either to keep your earnings below the limit or delay claiming benefits until you reach full retirement age.

7. Buy an Annuity

Unless you’re a retired public service employee or you worked for one of the handful of companies that still offer a traditional pension (see below), you’re not going to receive a monthly paycheck from your employer for the rest of your life. But that doesn’t mean that a guaranteed source of lifetime income is an impossible dream. You can create your own pension by buying an immediate fixed annuity.

When you buy an immediate annuity, you give an insurance company a lump sum in exchange for a monthly check, usually for life. You can buy an annuity that has survivor benefits so that it will continue to pay your spouse after you die. But you pay for that protection by accepting smaller monthly payouts. Another option is a deferred-income annuity; you purchase the annuity when you’re in your fifties or sixties, but the payments don’t start for at least 10 years. The longer you wait, the bigger the payouts. Of course, if you die before payments start, you get nothing—unless you opt for return of premium or survivor benefits. (These products are often referred to as longevity insurance, because they protect you from the risk of outliving your savings.)

A relatively new type of deferred-income annuity, a qualified longevity annuity contract (QLAC), offers a tax benefit for retirees who have a lot of money in tax-deferred retirement accounts. You can invest up to 25% of your traditional IRA or 401(k) plan (or $125,000, whichever is less) in a QLAC without taking required minimum distributions on that money when you turn 70½. To qualify for this special tax treatment, your payments must begin no later than age 85.

An analysis by New York Life illustrates how this strategy could lower your tax bill. A 70-year-old retiree in the 28% tax bracket with $500,000 in an IRA would pay about $117,000 in taxes on RMDs between age 70 and 85, assuming 5% annual net returns. If the retiree opted instead to put 25% of the IRA balance into a QLAC at age 70, he would pay roughly $87,000 in taxes over the same period—a $30,000 reduction. Taxes would increase, however, once the annuity payments began at 85.

KIP TIP: Don’t stash all of your nest egg in an annuity. Most experts recommend investing no more than 25% to 40% of your savings in an annuity. Alternatively, calculate your basic expenses, such as your mortgage, property taxes and utilities, and buy an annuity that, when added to Social Security benefits, will cover those costs.

8. Minimize Taxes

To get the most out of your retirement savings, you need to shield as much as possible from Uncle Sam. Fortunately, there are plenty of legal ways to lower your tax bill, but they require careful planning and a thorough understanding of how your different retirement accounts are taxed.

Let’s start with your taxable brokerage accounts—money you haven’t invested in an IRA or other tax-deferred account. Because you’ve already paid taxes on that money, you’ll be taxed only on interest and dividends as they’re earned and capital gains when you sell an asset. The top long-term capital gains rate—which applies to assets held for more than a year—is 23.8%, but most taxpayers pay 15%. The rate is 0% for taxpayers in the 10% or 15% bracket. For 2017, a married couple with income of $75,900 or less can qualify for this sweet deal.

Next up: your tax-deferred accounts, such as your IRAs and 401(k) plans. Withdrawals from these accounts are taxed at ordinary income rates, which range from 10% to 39.6%. The accounts grow tax-deferred until you take withdrawals, but you can’t wait forever. Once you turn 70½, you’ll have to take required minimum distributions (RMDs) every year, based on the year-end balance of all of your tax-deferred accounts, divided by a life-expectancy factor provided by the IRS that’s based on your age. The only exception to this rule applies if you are still working at 70½ and have a 401(k) plan with your current employer; in that case, you don’t have to take RMDs from that account. You’ll still have to take withdrawals from your other 401(k) plans and traditional IRAs, unless your employer allows you to roll them into your 401(k).

Finally, there are Roth IRAs, and the rules for them are refreshingly straightforward: All withdrawals are tax-free, as long as you’ve owned the account for at least five years (you can withdraw contributions tax-free at any time). There are no required distributions, so if you don’t need the money, you can leave it in the account to grow for your heirs. This flexibility makes the Roth an invaluable apparatus in your retirement toolkit. If you need money for a major expense, you can take a large withdrawal without triggering a tax bill. And if you don’t need the money, the account will continue to grow, unencumbered by taxes.

Conventional wisdom holds that you should tap your taxable accounts first, particularly if your income is low enough to qualify for tax-free capital gains. Next, take withdrawals from your tax-deferred accounts, followed by your tax-free Roth accounts so you can take advantage of tax-deferred and tax-free growth.

There are some exceptions to this hierarchy. If you have a large amount of money in traditional IRAs and 401(k) plans, your RMDs could push you into a higher tax bracket. To avoid that scenario, consider taking withdrawals from your tax-deferred accounts before you turn 70½. Work with a financial planner or tax professional to ensure that the amount you withdraw won’t propel you into a higher tax bracket or trigger other taxes tied to your adjusted gross income, such as taxes on your Social Security benefits. The withdrawals will shrink the size of your tax-deferred accounts, thus reducing the amount you’ll be required to take out when you turn 70½.

Another strategy to reduce taxes on your IRAs and 401(k) plans is to convert some of that money to a Roth. One downside: The conversion will be taxed as ordinary income and could bump you into a higher tax bracket. To avoid bracket creep, roll a portion of your IRA into a Roth every year, with an eye toward how the transaction will affect your taxable income.

KIP TIP: If the stock market takes a dive, you may be able to reduce the cost of converting to a Roth. Your tax bill is based on the fair market value of the assets at the time of the conversion, so a depressed portfolio will leave you with a lower tax bill. If your investments rebound after the conversion, those gains, now protected inside a Roth, will be tax-free. Should the value of your assets continue to plummet after you convert, there’s a safety valve: You have until the following year’s tax- filing extension (typically October 15) to undo the conversion and eliminate the tax bill. If prospects for major tax reform and rate cuts come to fruition, it could open a golden era for Roth conversions. Keep an eye on Congress.

9. Manage Your Pension

At a time when defined-benefit plans are becoming as rare as typewriters, consider yourself fortunate if you have a traditional pension to manage. Even so, the decisions you make about how you take your pension payout could have a significant impact on the amount of income you receive.

One of the first decisions you’ll probably have to make is whether to take your pension as a lump sum or as a lifetime payout. A lump sum could make sense if you have other assets, such as life insurance or a sizable investment portfolio, and if you’re comfortable managing your money (or paying someone else to do it for you). You’ll also have more flexibility to take withdrawals, and your investments could grow faster than the rate of inflation. What you don’t spend will go to your heirs.

A lifetime payout, however, offers protection against market downturns, and you won’t have to worry about outliving your money. You’ll probably also get a higher payout from your former employer than you could get by taking a lump sum and buying an annuity from an insurer.

Consider longevity when deciding how to structure your lifetime payout. Married couples have a couple of basic options for their payments: single life or joint and survivor. Taking the single-life payment will deliver bigger monthly payments, but your pension will end when you die. By law, if you’re married, you must obtain your spouse’s consent before taking this option. With the joint-and-survivor alternative, payments will be smaller, but they’ll continue as long as you or your spouse is alive.

The survivor benefit is based on the pension participant’s benefit. Plans must offer a 50% option, which pays the survivor 50% of the joint benefit. Other survivor-benefit options range from 66% to 100% of the joint benefit. In most cases, the benefit drops no matter who dies first, unless you choose the 100% option.

KIP TIP: In general, women who want lifetime income should take the pension’s monthly payout. Pension plans use gender-neutral calculations, which can further complicate the choice of monthly payments versus a lump sum. Because women tend to live longer than men, it’s highly likely that the pension plan will offer a higher payout than they could get on the open market. For example, a 65-year-old man who wants to buy an annuity that will provide $60,000 a year for life would need about $914,000. A 65-year-old woman would need about $955,000—roughly $40,000 more—to get the same amount of annual income. If you take the pension, however, your payment is based on your years of service and salary; your gender doesn’t play a role.

When it comes to converting the pension payment to a lump sum, however, gender neutrality can work against women. If their longer life expectancy could be taken into account, the lump sum would have to be larger to equate to the higher lifetime costs of the monthly payments.

10. Tap Permanent Life Insurance

Most of us buy life insurance to provide financial security for our loved ones after we’re gone, but a permanent life insurance policy could provide a valuable source of income while you’re still around to enjoy it.

A permanent life insurance policy has two components: the death benefit, which is the amount that will be paid to your beneficiaries when you die, and the cash value, a tax-advantaged savings account that’s funded by a portion of your premiums. With whole life and universal life, the insurance company usually promises that a minimal level of interest, after insurance costs and expenses are deducted, will be credited to your account every year. With variable life insurance policies, you choose the investments and may not get a guarantee.

You can withdraw your basis—the amount in the cash-value account you’ve paid in premiums—tax-free. That could provide a cash cushion in case, say, the stock market takes a 2008-style downturn and you want to give your portfolio a chance to recover. (Withdrawals that exceed what’s in the cash-value account will be taxed in your top tax bracket.) The death benefit will be reduced by the total amount you withdraw. You can also borrow against your policy, and you won’t have to undergo a credit check. Interest rates range from 5% to 8%, depending on market rates and whether the loan is fixed or variable. If you don’t repay the loan, or pay back only part of it, the balance will be deducted from your death benefit when you die.

When you borrow against your policy, you’re not taking withdrawals from your account that you’ll pay back later, as is the case with a 401(k) loan. Rather, the insurer is lending you money and using your policy as collateral. Unless you pay the interest out of pocket, it will be added to the loan balance. If the balance exceeds the policy’s cash value, the policy could lapse, and you’ll owe taxes on the amount of the cash value, including loans, that exceed the premiums you paid.

What if you need a regular source of income? One option is to convert your life insurance into an income annuity through what’s known as a 1035 exchange. The downside to this strategy is that you’ll give up the death benefit, but you’ll lock in income for the rest of your life, or for a specific number of years. The conversion is tax-free, but you’ll pay taxes on a portion of each payout, based on the proportion of your basis to your gains. Your insurance company may offer an income annuity, but you should look at payouts offered by other providers, too.

KIP TIP: If your insurance policy pays dividends, you can generate income without giving up the death benefit. Instead of reinvesting the dividends in the policy, which will increase its death benefit and cash value, you can take the dividends in cash. Dividends typically range from 5% to 6.7%, and any dividends you receive up to the policy’s cost basis are tax-free. Dividends that exceed that amount are taxable.

11. Plan for Health Care Costs

Fidelity Investments estimates that the average 65-year-old couple retiring now will need about $260,000 to pay out-of-pocket health care costs, including deductibles and Medicare premiums, over the rest of their lives. That doesn’t include long-term care, which can be a major budget buster.

There are a variety of options to help pay these future medical bills. One tax-friendly way is a health savings account. As long as you have an eligible high-deductible health insurance policy, you can contribute to an HSA either through your employer or on your own (but you can no longer contribute after you’ve signed up for Medicare).

An HSA offers a triple tax advantage. You contribute money on a pretax basis to the account. Money in the account grows tax-deferred. And withdrawals are tax-free if used to pay medical expenses, either today or when you’re retired. (You’ll owe income taxes and a 20% penalty on withdrawals used for other purposes, although the penalty disappears once you turn 65.)

To make the most of the HSA, contribute as much as you can to the account and pay current medical bills out of pocket. That way, the money in the account has time to grow. Years from now, you can use HSA funds to reimburse yourself for medical bills you’re paying today.

The maximum contribution for 2017 is $3,400 for single coverage and $6,750 for families, plus an extra $1,000 if you’re 55 or older. Your health insurance policy must have a deductible of at least $1,300 for singles and $2,600 for families.

Employers are increasingly offering workers this option to contain costs because premiums for high-deductible plans tend to be lower than for traditional insurance. Among Fidelity-run plans, nine out of 10 employers kick in money to workers’ accounts to encourage participation, says Eric Dowley, senior vice president of Fidelity’s HSA product management. The average employer contribution is $541 for singles and $991 for families.

If you’re looking for an HSA on your own, review fees and investment options. Morningstar recently looked at plans offered by the 10 most prominent providers and found that only one—offered by The HSA Authority—did a good job for both current spending and future investing.

You can use HSA funds to pay for long-term-care premiums—but that’s a small compensation given the steep price tag for a long-term-care policy. If you can’t afford a long-term-care policy that would cover at least three years of long-term care with inflation protection, another option is to buy enough coverage to pay the difference between the cost of care for three years and what you can afford to pay from savings and income.

Another solution: a hybrid policy that combines life insurance and long-term-care benefits. It’s basically a permanent life insurance policy that allows you to spend down the death benefit to pay for long-term care should you need it. You can also get a rider that will cover long-term care above and beyond the death benefit. If you don’t need long-term care or don’t entirely use up the death benefit, your heirs will collect what remains of it.

Lincoln National, for example, offers a hybrid policy called MoneyGuard that you purchase with an up-front lump sum or in installments over 10 years. A 60-year-old man paying $10,000 a year over a decade could get monthly long-term-care benefits at age 80 of $7,983 for up to six years, growing at 3% annually. The death benefit at that point would total $106,400, or he could cash in the policy and get 80% of his premiums returned. Under a similar scenario, a woman would get $7,076 per month for long-term care or a $113,600 death benefit.

The trade-off is that hybrid policies are doing double duty, so you’ll get a lower long-term-care benefit for your money than if you purchased a stand-alone long-term-care policy, says Bill Dyess, president of Dyess Insurance Services, in Boca Raton, Fla.

KIP TIP: If paying for long-term care is your chief goal and you don’t need more life insurance, buy a stand-alone policy rather than a hybrid policy. Today’s long-term-care policies are more accurately priced than those issued years ago, so it’s less likely that you’ll see steep premium jumps in the future, says Pinnacle’s Kitces. Plus, you may be able to deduct part of your premiums on your tax return, something you generally can’t do with a hybrid policy.

12. Move to a Cheaper Locale

Downsizing to a smaller place, particularly after the kids are launched, is a common way to lower housing costs and stay close to family. If you live in a highly appreciated home, selling can free up large sums that can be used to wipe out debt, add to a nest egg or pay future long-term-care costs. (Married couples can protect up to $500,000 in profit from the sale of a house from capital gains tax; singles can shelter half that amount.)

But for a move to become a financial game changer and significantly lower living costs, consider putting down roots in a state where housing and living expenses are cheaper.

“This can take a retirement situation that is nearly hopeless and turn it into one that is comfortable,” says Tim Maurer, director of personal finance for BAMAlliance in Charleston, S.C. For example, housing costs in San Diego are 173% higher than in Galveston, Texas, according to Bestplaces.net. Galveston made Kiplinger’s most recent list of great places to retire. Kiplinger also compiles a list of the most tax-friendly states for retirees. Moving to a state that gives retirees a big tax break can free up money for a higher standard of living in retirement. (If you want to stay in your home and tap the equity for income, see Use Your Home to Get More Income.)

Kevin McGrain, 62, was able to retire last year as an executive of a catalog company after he moved from the Northeast to the Sun Belt. Two years ago, McGrain and his wife, Linda, traded in a $700,000 four-bedroom house on a small lot in Newburyport, Mass., for a $400,000 four-bedroom home in Inman, S.C., that sits on an acre of lakefront property with a view of the Blue Ridge Mountains. He says he doesn’t think he could have retired when he did if he hadn’t moved to South Carolina.

In Massachusetts, the McGrains’ property taxes were $15,000 a year, and monthly utility bills some winters reached $600. In South Carolina, the couple’s property taxes run $1,700 a year, and at age 65 they’ll be eligible for a special exemption that will reduce that bill even further. Their utility bills now average $150 a month.

Better yet, McGrain, who is an avid golfer, says his country-club fees are half of what they used to be, and he can play 11 months out of the year instead of seven.

KIP TIP: Before moving to a new zip code, do some field research. Take an extended vacation to experience day-to-day living in the new neighborhood you’re considering (you may be able to rent a place via Airbnb or VRBO). Visit in the off-season to see if the weather agrees with you. And meet up with a local real estate agent for a lowdown on the area.

11 ways to protect your money, and sanity, as you age

June 5, 2004

As an old financial goat, I often get questions about aging from clients, seminar attendees and readers — even by email. I've no wondrous wisdom, but here are my 11 most offered tips that I sense few undertake:

  1. Take seriously the need to finance a long life: You’ll likely live lots longer than you expect. Lifespans keep increasing and will continue to. In 1952 expectancy averaged 68.6 years. By 2006 it was 77.8. If you and your spouse are 65, odds favor one of you hitting 90. Maybe older! Invest as if you'll reach that milestone. Doing otherwise invites aged poverty. Little is more brutal.
     
  2. Be clear early about family-support limits: Before it arises, decide with your spouse the limits on what you will and won’t do to support family members. Too much or too little causes bad outcomes. If the topic of support comes up, and you didn’t plan in advance, you will be too emotional and likely over or under give. Planning early saves relationships later.
     
  3. Consider downsizing: Saves money, makes life more manageable, eases future burdens on offspring, but causes more upfront hassle and reduces guest potential (which may be good).
     
  4. Consider upsizing: Big gatherings, room for lots of grandkids (nothing beats grandkids — get your kids to have more, which is the best tip of all). Negatives are higher cost and extra upkeep.
     
  5. Consider moving closer to grandkids: Fun. And maybe you can coerce your no-good kids to do more for you. And if your kids are good — you will want them helping you as you age. All good.
     
  6. If you can, involve offspring in your financial decisions: This requires that they are up to it. But the more you can do this, the less hostility will arise over time. And, as per above, you likely want and need their help eventually. Plus, you’ll learn a whole new side of them.
     
  7. Drive the safest car you can: When I was young I hot-rodded. Now I know I can’t drive as well as I could (or thought I could). Time is against you. It only takes one idiot to ruin your life. That idiot could be you. My wife and kids were saved by her Volvo in the ‘80s in a head-on with a drunk. I came to love Volvo real fast. Cars are even safer now. Opt against the road idiot.
     
  8. Build a cushion into your financial plan: Not everyone is highly disciplined about spending and planning. If you suffer a big gap between plans and realities, it causes anxiety — which makes for worse investors and hence worse results. Create an extra cushion year by year so at the end you aren’t trying to catch the ball with extremely shaky hands.
     
  9. Know your net worth but don’t obsess over it: J. Paul Getty, when America’s richest man, famously said that really rich people hadn’t a close clue what they were worth because they owned illiquid assets that were impossible to price. If you aren’t rich, obsessing over exactly what you’re worth makes even less sense. Your sense of net worth is just a planning tool for the future.
     
  10. Have a financial back-up person — or two: Whether you, a loved one or a professional, be clear who should oversee your finances if you’re numero uno choice can’t. If you ever need it, that decision made in haste and emotion could be as expensive as any. 
     
  11. Remember that anger slays: I got huge peace of mind when a psychologist buddy taught me to live my actions as if I’d live forever and my emotions as if I knew I’d be dead in 30 days. Every time I anger, I ask myself if I’d waste time over “this” if I knew I had only 30 days to live. I never do. It’s calming. Anger slays investors and you.

5 bad financial habits to eliminate before starting a business

May 25, 2004

5 bad financial habits to eliminate before starting a business

Managing your finances can be really stressful. There’s so much information to know, mastering all of it seems like an impossible task. Moreover, if you’ve developed some bad financial habits over the years, correcting them may seem extremely daunting.

Luckily, it is possible to improve your financial prowess. With a little effort, you will set yourself up for a better financial future, which can be a real benefit when it comes to starting a business. As you overcome your bad financial habits and instill new, good habits, you’ll learn how to manage not only your personal finances but business finances, too.

If you want to become more successful and get closer to starting your own business, you need to give up the five habits below. Some of them you’ll be able to give up today, while others will take a little bit longer to overcome. There might be some hard work involved to rewrite these five behaviors, but once you do, you’ll find that the work was well worth the outcome.

1) Living paycheck to paycheck

Very often, people have no idea what they’re actually spending all of their money on. Before they know it, their bank account is approaching zero, and they’re simply waiting for their next paycheck to come. The bottom line is this: without paying attention, it’s easy to spend the money you should be saving.

If you’d like to break out of this vicious cycle, the first step is to start tracking your expenses. If you don’t know where all of your money is going, you can’t give it a purpose. So, track every dollar, understand how much is going in and how much is going out. With this information in mind, you can overcome the bad habit of living paycheck to paycheck.

2) Avoiding a budget 

Figuring out exactly how much money is coming in and going out is the first step to financial freedom, but it’s not the only step. Once you have a grasp of your monthly income and expenses, you’ll need to create a budget.

Whether you’re managing your personal finances or your new company’s money, you should always have a budget in place. Creating a working plan that outlines how you’ll cover your expenses and save for the future is key to financial well-being.

3) Neglecting your credit score

Knowing your current credit score and how you can improve it is paramount to success. Unfortunately, 30 percent of Americans have a bad habit of not checking and knowing their credit scores. Whether you worry about having bad credit or not, you should check your credit score at least once a year. Even if you are doing everything right, errors on your credit report might cause you to have an inaccurate score that threatens your financial health.

Although neglecting your credit score is number three on this list, its importance shouldn’t be understated. When you start a new business, your credit will likely serve as your company’s credit history. To secure the best funding and financing available for your future company, you need to start managing and improving your personal score today.

4) Failing to review statements and bills

Every month — sometimes several times a month — statements and bills roll in. Many of these documents don’t seem to require immediate attention, so people only view them at the end of the month. However, not opening these documents as soon as they arrive can wreak havoc on your finances.

If you don’t view your statements when they arrive, you might miss out on important information that should inform your budget. Like your credit, it’s also not uncommon for incorrect items to make themselves onto your statements.

Additionally, although you might dread looking at bills, you should catalog and categorize them as soon as they arise. Accidentally neglecting to pay a bill you’ve forgotten about is all too easy, so don’t give yourself the chance. This is a bad habit that doesn’t help your personal finances, and it certainly isn’t something you’ll want to do when you’re running your own company.

5) Thinking you can manage everything

Many people — especially aspiring business owners — have a bad habit of thinking that they can do everything by themselves. There’s only so much you can learn about building, managing and preserving your finances.

Fortunately, you can work with a mentor or a financial advisor that can help you overcome your bad financial habits to achieve financial freedom.

How to plan your mutual fund investments. Read here

May 7, 2004

Over the years, mutual funds have come across as a popular and fairly profitable instrument of investment. They have proved to be more hassle free and risk averse as compared to direct stock investments.

Here is an insight on how you can plan your mutual fund investment:

Short-term investment

What?

As the name suggests, these investments are made for short periods of time, typically for 12-month duration or even less.

When?

These investments are a boon in emergency situations. Be it a medical emergency or the sudden need of money for down payment of your car, short term mutual funds can bail you out.

What to keep in mind?

Since the investment is for a brief period, it needs to be ensured that your investment is insulated from market volatility. It is important as you would not want to see your investment numbers cut a sorry figure at the time of emergency. So, it is advised to invest in low-risk options -- liquid funds like Commercial Papers (CPs) and T-Bills or debt funds like government bonds, company debentures, fixed income assets etc.

Mid-term investment

What?

These kind of mutual fund investments are made for a period of 1-3 years

When?

If you are planning to launch a start-up or a business, mid- term investments are your best bet. Experts say that these investments can be helpful in case you are planning to buy property or real estate.

What to keep in mind?

In mid-term investments, your aim should be to have the best of both worlds. That is, you should eye to maximize your capital gains but at the same time you cannot afford to take too much risk as the period of investment in this case, is still not very long. So you can choose to stick with debt funds or maybe opt for Systematic Investment Plan (SIP) or monthly investments. SIP in mutual fund is recommended as a great way for a salaried person to invest in equity markets for long-term basis without understanding the working of equity markets.

Long-term investment

What?

Any mutual fund investment for a period of more than three years is termed as a long-term investment.

When?

As it is quite evident from the nature of the investment, long-term investments hold good if you are planning for the future. If you want to sort out your retirement plans, save for old- age health issues or nurture your child's education, you should definitely go for long-term investments.

What to keep in mind?

Since the investment is a long-drawn one, you can take down your guards off to some extent, against market volatility. You won't mind taking a few risks to rake in the maximum possible profits. So you can choose to invest in equity funds i.e. in shares of companies.

How to Take Advantage of New Investment Opportunities like Cryptocurrency Funds

April 25, 2004

How To Take Advantage Of New Investment Opportunities Like Cryptocurrency Funds

Growing up is scary. Going from not having a care in the world to taking care of everything yourself can be a daunting task. Just paying the bills and buying groceries is enough, but when you start to think about savings and investment portfolios, the adult world can become overwhelming.

There’s your retirement fund—known as a 401K—at your job, of course. However, understanding how your 401K makes money can be a little confusing. Once you start thinking about how to invest your savings without help, personal finances can become a formidable proposition.

According to NerdWallet, over 60 percent of people 18-34 are opting to use savings accounts to set money aside for retirement. If they set enough aside each month, they may still be in good shape come retirement. But if they invest, they could be significantly better prepared.

If you are a risk-averse millennial that fears another stock crash like the mortgage crisis in 2008, technology may have an intriguing solution. The rise of cryptocurrencies such as Bitcoin, as well as safe ways to invest in them has led to an intriguing financial opportunity – cryptocurrency-based investment funds.

What Is A Cryptocurrency?

To explain what a cryptocurrency fund is, it is important to first understand the breakdown of the assets in the fund’s portfolio. Investing in cryptocurrencies such as Bitcoin, Ethereum, Ripple, and Dash is very similar to investing in currencies. People can use them for buying and selling and can invest in them as they would US Dollars or Euros. However, unlike their traditional counterparts, these cryptocurrencies have a limited supply, and they have to be “mined” in order to be used.

Bitcoin became the first mainstream decentralized cryptocurrency in 2009. Since then, several others including Ethereum, LiteCoin and Dash have become increasingly popular, attracting new traders and investors thus increasing the overall market cap significantly.

What Is A Cryptocurrency-based Investment Fund?

The easiest way to describe a cryptocurrency-based investment fund is to compare it to its traditional counterpart, the classic investment fund. In a traditional fund, your money is allocated between several different investments. Some entail more risk than others, which of course brings more reward. The growth of your equity depends on the volatility of the market and the type of investments that make up the fund.

Cryptocurrency funds operate in a similar fashion. eToro’s Crypto Copyfund, for example, is based on a diverse portfolio, currently allocating different percentages to six different cryptocurrencies (Bitcoin, Ethereum, Litecoin, Ripple, Dash, and Ethereum Classic), currently led by Bitcoin, and rebalanced on the first trading day of each calendar month.

This fund focuses on cryptocurrencies with a market cap of at least $1 billion (with a roundup of up to 2%) and a minimum average monthly trading volume of $20 million. The weight of each of the CopyFund’s components is decided according by market cap, with a minimum of 5%.

Other funds, such as those offered by Metis Management, prefer a more diversified investment portfolio, reserving part of their capital to invest in newer, more radical digital currencies.

As cryptocurrencies have gained in popularity, cryptocurrency investment funds have opened the doors to respond to the increasing demand to trade these digital assets in a more regulated way. With several cryptocurrency exchanges operating around the world, cryptocurrency investment funds offer investors a relatively safe method to invest or trade in digital currencies and increase their exposure to a potentially high-value asset class.

Are Crypto CopyFunds Worth the Investment?

With most new investment trends, it helps to be in on the ground floor. While cryptocurrencies have reached a new phase in their maturity as an investment asset, it’s still possible to get excellent returns investing in them. The top 100 cryptocurrencies have already surpassed $100 billion in value, with Bitcoin accounting for the lion’s share.

While they still hold more risk than traditional currencies and other assets, cryptocurrencies are becoming an established opportunity to diversify any investment portfolio. The value of each might remain volatile, but the popularity of cryptocurrencies is expected to continue to increase.

Cryptocurrency investment and copy funds such as eToro’s can help investors mediate risk by providing a diversified and transparent way to spread capital amongst the best-performing cryptocurrencies for the highest returns.

In addition, since this is a managed fund that updates on a monthly basis with the top cryptocurrencies, it provides a solution for investors interested in diversifying their portfolio with cryptocurrencies, but lack the time or knowledge to capitalize from them.

While cryptocurrency prices will undoubtedly fluctuate in coming months and years, finding a way to safely invest and have exposure to one of the fastest-rising investment trends is a vital for forward-thinking traders.

If You Must Invest in Commodities, Here's How

April 12, 2004

There are ways to access the asset class without investing directly in futures.

I recently wrote about how commodities are good for traders, but bad for investors as a useful long-term buy-and-hold financial asset. A broad basket of commodities has given investors lower returns than cash equivalents with higher volatility than stocks.

That higher volatility means there will be cyclical swings where commodities see huge gains as well as huge losses. The question many investors should ask themselves is this: Is there a better way to invest in commodities since the long-term risk-reward profile is so poor?

Commodities are a hedge against much higher inflation, so the past 30 years or so of disinflation haven’t been conducive to strong performance, but there are ways to access commodities in their portfolios without investing directly in futures.

Own an index fund. The simplest way to gain exposure to commodities is to own a broadly diversified index fund. The SPDR S&P 500 ETF currently has around 6 percent of its holdings in energy stocks and another 3 percent in basic materials. Foreign stocks have an even higher commodities tilt. The iShares MSCI EAFE ETF has 5 percent in energy names and 8 percent in basic materials while the Vanguard FTSE Emerging Markets ETF has 7 percent and 9 percent, respectively.

Invest in sector ETFs. You could also invest directly in these sectors. While this is a much more concentrated bet, ETFs now make it easier than ever to make a bet at the sector or industry level. Here are the returns since 1999 for the SPDR Energy ETF and the SPDR Basic Materials ETF compared to the Bloomberg Commodities Index:

Both funds have performed much better than commodities with similar volatility characteristics. The only problem with investing in sector funds is that they still have a fairly high correlation to the overall stock market. The correlations for XLE and XLB to the S&P 500 were 0.62 and 0.88 over this time frame. Many investors put their money into commodities in hopes of finding an uncorrelated portfolio diversifier, which sector funds may not provide.

Invest in companies that mine commodities. Instead of owning the commodities themselves you could simply own equity in the companies that extract them and put them to use. The Vanguard Metals & Mining Fund does just that. Here are the stats in comparison to the S&P 500 and Bloomberg Commodities Index:

This fund had just a 0.05 correlation to the S&P 500 in this time, meaning there is virtually no relationship between the return streams. It also had better returns than commodities, but it did so with much higher volatility. It also comes with bone-crushing losses that can be similar to the underlying commodities:

There have been periods when physical commodities decouple from the equities of the mining companies but both are still quite cyclical. When looking at the types of losses and volatility involved in precious metals and mining stocks it makes for a difficult portfolio holding, even if it ends up providing valuable diversification benefits. Very few investors have the emotional stamina to hold through this type of volatility or rebalance into the pain when necessary.

Stick to trend-following rules. Because of the cyclical nature of commodities they can work much better through the use of trend-following rules. Trend-following as an investment strategy seeks to follow the old maxim that you should allow your winners to run but cut your losers short. The goal of trend-following is to reduce volatility and the potential for large drawdowns.

The following table compares commodities, stocks and a simple commodities trend-following strategy since 1991:

Our trend-following strategy in this example follows a simple 10-month moving average rule. Using the same Vanguard Precious Metals & Mining Fund, this strategy shows what would have happened if you would have held that fund when it was above its trailing 10-month moving average price and sold it to buy bonds whenever it dipped below the 10-month moving average.

Not only does a trend-following strategy cut the volatility by roughly one-third in this fund, but it also reduces the maximum drawdown in the fund from minus 76 percent to minus 33 percent by going to bonds as losses and volatility began to pile up.

This example doesn’t include taxes or transaction cost but it does show how investors can use the cyclical nature of these securities to their advantage. The basic idea is to ride the momentum up when they are rising and try to get out of the way when they are falling, with the understanding that you can’t nail the timing perfectly in either direction.

As you can see from the statistics, none of these strategies will be for the faint of heart. But investors do have options beyond investing directly in long-only commodity indexes if they would like to invest in this space.

How to Speculate In ICOs: 10 Practical Financial Tips

April 2, 2004

1. Understand the technological risks.

Even Olaf Carlson-Wee (who was on the July cover of Forbes), the founder and chief executive officer of Polychain Capital, a $200 million crypto hedge fund that began with $4 million last September, says the number one thing he wants everyday investors to know is, “This is unproven technology and if you don’t know what you’re doing, you shouldn’t interact with tokens — from an investor and security perspective. If you’re naively coming in and saying, I’m going to speculate on this, you’re really going to get burned. It’s like playing against the casino; you’re going to lose, even if you win sometimes.”

Crypto assets are not like regular money. They’re also a new technology, and you may not fully understand how to use that technology or, more specifically, secure your tokens. Tales abound of people who mined or otherwise obtained bitcoins back when they were worth almost nothing and stored them on old computers or thumb drives and then accidentally threw them out. (At least one unlucky soul even went to the dump to find his coins, which are worth $2,100 each today.) There’s also been a rash of thefts of bitcoins, ether and other tokens kept on centralized wallets and exchanges such as Coinbase or Xapo or Kraken or Poloniex (as opposed to user-controlled wallets) with hackers exploiting lax customer service agents at telcos, reseting victim’s passwords via text message and then transferring the victim’s crypto assets to the hacker’s own accounts.

2. Understand the business/economic risks.

The other reason crypto investing is riskier than traditional investing has to do with the fact that it depends on an emerging field called crypto-economics — the game theoretic system that largely determines a coin’s success. Tokens are trying to create mini economies that have incentives that get the various actors within the system to not just keep it afloat but increase the value of the token. But designing one that actually does those things isn’t easy. Developers could create a coin that enriches only a few and disillusions everyone else, leading the community to abandon the network. Or the business could fail, in which case, demand for their token will plummet, along with the price. Or they could design a really successful business, but design the coin poorly so it doesn’t appreciate along with the adoption of the platform. At this point, it’s not entirely clear what will make any particular token valuable, and even the two frontrunners could easily lose their status — perhaps to some competitor not yet in existence today, a la Yahoo.

Carlson-Wee’s advice? “Not to dabble in this with real stake. If you want to buy $10 of Ethereum, and poke around with smart contracts, I encourage that. But use it as a technology, not as an investment, unless you know what you’re doing.”

3. Understand the financial risks.

According to CryptoCompare, Bitcoin is down 15% for the last week alone. Ethereum is down 22% over the same time period — and 54% over the last month. Trading your USD for BTC or ETH is not the same as exchanging it for GBP or euros.

On June 11, in a Facebook group devoted to crypto trading, someone posted, “I’m strongly considering taking out a $15K loan (at 12% APR) to invest in ETH and BTC … Anyone want to convince me not to do it?” The first response, “Others might try to tell you to not pull out debt to invest, and while under normal circumstances that would be sound advice — these are not normal circumstances.” The comment got 23 likes.

June 11 happened to also be the day ETH hit its peak, at $394.66. If that investor did indeed invest his 12% APR-borrowed money in ETH on that day, he would, by now, have suffered a 57% loss. Only put in what you can afford to lose — which excludes taking on any debt — and only allocate money you won’t need for a while, in case you do buy in at the top and need to sit through a downturn.

4. Understand the legal risks.

Preston Byrne, a technology lawyer with expertise in virtual currencies, known for his view that tokens constitute securities, says, “There is the very distinct possibility that in 12 months’ time, some of [token sale holders] are going to be arrested and thrown into jail.” If that happens to a token you happened to invest in, your investment could very well tank.

The Securities and Exchange Commission has not yet made a ruling on whether initial coin offerings are legal or whether tokens are securities. The only public statements any official has made were in May by Valerie Szczepanik, the head of the SEC’s distributed ledger group, who, speaking for herself and not the agency, said at industry conference Consensus, “Whether or not something is a security is a facts-and-circumstances based test. … You have to pick each one apart, and figure out what are the rights and obligations created by the coin, what are the economic realities, what are the expectations of the parties, what does the white paper say, how do these things actually work and what are their key features?”

What she’s obliquely referring to here is the Howey test, which says that if the following four conditions are met, the offering is a security: It is (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profit predominantly (4) from the efforts of others. To summarize a framework put together by wallet and exchange Coinbase, blockchain advocacy group Coin Center, VC firm Union Square Ventures and Ethereum project hub ConsenSys, token sales fit point 1. Whether or not it’s a common enterprise depends on factors like whether the network is live before the token sale or at least operational on a test network. If the crowdsale occurs only when the team has published a white paper but has no tech yet, then that makes the buyers dependent on the actions of the developers, which makes it less of a common enterprise and more like a security. An additional factor considered beyond the Howey test is whether the offering is structured less as a utility token (a token that gives users the ability to do something in the network) and more like a token that entitles the user to equity or a shared of profits. The latter are securities. (Listen to my podcast with Coin Center's Jerry Brito and Peter van Valkenburgh to hear more about the Howey test and what factors determine whether a token is a security.)

Although numerous players, such as Carlson-Wee and USV partner Fred Wilson, have pointed out that regulators’ hands are somewhat tied because too draconian regulation could lead U.S. investors to flee to wallets and exchanges in other jurisdictions, where they will be even more vulnerable, that does not negate the fact that these investments come with a huge dose of regulatory uncertainty.

5. Understand that most projects will fail.

Many observers believe the current frenzy in ICOs is similar to the internet bubble of the late ’90s (and it likely hasn’t even hit its most fevered pitch yet), which means the Pets.com, Webvan and Kozmo.com are currently among us or about to launch, but not identified. However, the Amazon and eBay of crypto could also be getting started right now.

Fred Ehrsam, cofounder of Coinbase who left this past winter, says blockchain companies and protocols can form more quickly than C-corps, just as internet startups could form more quickly than pre-internet companies. He also believes these these protocols could be more valuable someday than any C-corp. However, he says, “For every one massive hit and three base hits, there are 100 failures. I don’t think the market is pricing that in at all. Right now all valuations are high. I think there’s going to be a serious shakeout, where there will be a few key and critical infrastructure tokens that are clear winners. There are also some tokens out there that are highly unlikely to succeed and those are wildly overpriced.”

6. If you’re still determined to invest in crypto, only do so if the rest of your financial life is in order.

If, despite all these risks, you still decide to put your money in a highly speculative investment, Ford recommends you be living below your means, be debt-free, have an appropriate amount of emergency savings (usually, anywhere from three to 12 months’ worth of essential expenses depending on your personal circumstances), and be on track with big financial goals such as saving for retirement and your children’s college tuitions. "You have to be comfortable losing everything," she says.

7. Only put in as much as or less than you can afford to lose.

The bulk of your investments should be in a “lockbox” — a “set it and forget it” diversified portfolio that acts as a piggy bank and that requires several steps from you before you can withdraw, says Kirsch. With this amount, you should be able to meet all your financial goals, such as amassing an adequate retirement nest egg, saving for your children’s college education or coming up with a down payment on a house. After that, depending on your net worth and how likely it is you will reach your goals, you could put anywhere from 1-10% of your net worth (only an amount you could lose but still meet your financial goals) into what he calls a “sandbox” — a diversified portfolio of riskier investments. In this case, he wouldn’t even recommend an investor put their full sandbox into crypto, even if it was invested in multiple tokens.

Similarly, Naval Ravikant, cofounder and CEO of AngelList and venture partner of crypto hedge fund Metastable Capital, advises would-be speculators treat it like the speculative investment it is, while paying attention to fundamentals and trying to diversify. “The scammers are smarter than you,” he says. (In the cover story, he recounted that a token creator offered him a deal that would be considered illegal if it were for a security and that would give him a lower price than what was offered in the token sale.)

“Take a very small amount of money, your throwaway money, treat it as if it’s already gone, you’ve mentally set it on fire, and put it in some distribution of a few truly legit layer 1 blockchains.” By that, he means tokens that fit into what Chris Burniske, the first buy-side analyst to focus exclusively on cryptoassets and author of the forthcoming book "Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond,” described in the cover story as crypto currencies and crypto commodities. For instance, some leading cryptocurrencies and commodities are Bitcoin (digital cash), Ether (gasoline for smart contracts), Zcash (privacy coin) and Monero (privacy coin). Another one that many experts believe has potential to become a foundational token is Tezos (smart contracts platform), but because the network isn't live yet and there's so much hype -- it raised the most of any crowdsale ever, plus got investment from VC Tim Draper -- this is the riskiest among this group of seeming safe bets.

8. Do your research so you understand what you’re buying.

Read the white paper, join the Slack community, and research the development team. If you can’t find much information on them, then it’s not easy to hold someone accountable, whereas developers with strong reputations will want to deliver. It’s also best to choose projects that have a minimum viable product, to lessen the risk the token will be considered a security. Get a sense of the network’s game theory, and learn to evaluate the token separately from the business model, so you’re not stuck holding a token that won’t appreciate no matter how popular its platform gets. “Do your due diligence. Don’t buy because your neighbor is buying,” says Burniske.

9. Evaluate the crypto-economics.

To find real value, look for a token that is integral to the function of the network and whose value should rise if the platform catches on. Stan Miroshnik, managing director of The Element Group, an investment bank for the cryptocurrency and token-based capital markets, who gets queries from Russia, Kazakhstan, Indonesia, Malaysia, countries in Latin America and all over the world, says he asks founders who come to him, “What purpose does a token have for your company’s ecosystem? Or is it something exogenous you’re creating just to access this funding environment?” You should be asking yourself the same — and avoiding any investments in the latter category.

10. Unless you’ve decided to day trade, don’t watch the price.

Presuming that because of your research, you believe in your investment, and presuming that you could lose all the money you invested and still reach all your financial goals, you don’t need to watch the price of your investments every day. If you made a rational investment decision, then don’t let your emotions negate your hard work during a price swing.

Kirsch recommends that his clients who have “sandbox” investments look only quarterly or semiannually and not make any immediate changes but give themselves a few days to think about it and then either leave their investments be or switch things up. “I’m not against checking your portfolio and making changes as long as it’s a process and not emotionally driven,” he says.

This weekend, all cryptocurrencies suffered a blood bath. Now, this Monday morning, they’re all up. If you’ve decided to put your money in, make sure you have the stomach for what is certain to be a wild ride.

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