Biggest Lesson Learned from this Bear Market

January 20, 2009

The bear market has taken a huge toll on everybody’s investments. I read numerous personal finance blogs, most of which write an end of year financial status round-up. Many of these bloggers are experiencing significant declines in stock market investments, so much that their net worth has decreased over the course of 2008. Fortunately, the majority of my savings was held in cash for a condo down payment. For this reason I didn’t experience too much of an effect from this bear market, however, I did learn a very valuable lesson from this bear market, know your risk aversion.

Risk Aversion

Risk aversion is how well you handle risk. A risk averse person will trade higher returns in order to lower risk. A less risk averse person will take on higher risk to gain higher returns. Risk aversion is not something that is consistent from person to person. Knowing the degree of your risk aversion is crucial to surviving the ups and downs of the stock market.

If you have never experienced a bear market, which was true for me up until now, you may think you aren’t risk averse, that is until you’ve lost 50% of your portfolio. Everybody can ride the market highs, but can your stomach handle the lows?

Not knowing your how risk averse you are can lead to making one of the largest mistakes of your investing career: buy high and sell low.

Past Bear Markets

Even though I didn’t have a lot of money in the stock market, I have learned that I have a high tolerance for risk. I know that I am just beginning my investment journey and I have over 30 years to recoup any early losses. Studying past bear markets has made me confident that the market will rebound and rebound in a big way.

Investing at today’s discounted prices is the equivalent of investing in 1997, at least according to the S&P 500. Back in 1997, the S&P 500 was in the 800 range, the same as it is right now. That’s 11 years worth of stock investing that I hope to take advantage of when the market rebounds.

Also, a market similar to the current market existed between the years of 1963 to 1974. In 1963, the S&P 500 was in the 60’s. The S&P 500 peaked around 118 in 1972 before taking a nosedive back to the 60’s in 1974. If you had sold your position because you did not correctly know how risk averse you were, you would have missed out on the gains the next 11 years provided. Over the course of the next 11 years, the S&P 500 increased in value into the 250’s.

Conclusion

The stock market is not guaranteed to increase over the short-term. Over the long haul, however, the stock market will outpace inflation and help secure a happy and financially independent retirement. A bear market such as our current market, is the only time to really be able to determine how risk averse you are. Can you sleep at night knowing that up to 50% of your retirement savings have vanished over the past year? Can you sleep easily knowing the loss is only a paper loss and the market will rebound? Are you willing to pump extra money into the market during a bear market? Your answers to these questions will help you determine a suitable stock/bond ratio for your investment plan. I’m confident that the stock market will rebound and if you don’t believe me, check out the history of the S&P 500 for yourself.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS

mr_1_468x60


Sign-Up for a Lending Club Account and Receive a $50 Lending Bonus

January 19, 2009

Lending Club is a social lending network that connects lenders and borrowers through investing in notes. You may loan as little as $25 or as much as you want. Lending Club makes money by charging a processing fee from the borrower and a servicing fee from the lender. The processing fee is a percentage between 0.75 and 3.00% of the loan amount. The service fee is 1% of each payment from the borrower.

The benefits of investing money through loans is that Lending Club allows you to earn between 6.69 and 19.37% depending on the rating of the borrower. Lending money does involve some risk as the borrowers may default on the loan. Another benefit is the $50 bonus for signing up through my referral (I don’t believe I make any money on this transaction). The following is a step-by-step guide on how to sign up for a Lending Club account and receive your $50 bonus.

Create Lending Club Member Account

Creating a Lending Club member account is super easy. If you are interested in a $50 referral bonus leave a comment or email me (pfstartup@gmail.com) and I will send you an email invitation. I don’t think I get anything out of this, but $50 is enough to fund two separate loans.

If you’re not interested in a $50 bonus, just follow this LINK. Creating a member account requires the following information: email address, password, security question, security answer, screen name and a human verification code. Also, you have to agree to the Terms of Use. After selecting next, all you have to do is wait for a confirmation email.

Enable Investing

Once you receive your confirmation e-mail and have followed it to Lending Club’s website, you can click on “My Account”. You are given two options: Invest or Get a Loan. Select Invest and you are taken to a 4 step set-up process.

The first page is your personal information and a few agreements. For personal information you have to enter the following: first name, last name, SSN, DOB, street address, city, state, zip code and home phone. Additionally, you have to agree to the note purchase agreement, no tax withholding and declaration of trust.

Step 2 deals with identity verification. Apparently, my identity has already been verified, moving right along…

Step 3 requires the necessary banking information to link to an external account. The required information is account holder’s first name, account holder’s last name, name of bank, routing number and account number. Also, a bank account verification and debit authorization agreement is required.

The final step is unique when compared to other investing account sign-ups. Lending Club claims that borrowers are less likely to default on a loan if they feel connected to you. The final step allows you to designate your geography, education, workplace and other associations, which will appear publicly next to your screen name.

Now you are ready to be a Lending Club lender. They use an interesting method of verifying your bank account. Most places send trial deposits into your bank account. Lending Club removes a value less than $1 from your account and puts it into your Lending Club account. You then verify this amount in your account section of Lending Club.

Security

Lending Club uses Secure Socket Layer (SSL) certificate technology to secure website connections. SSL also ensures that all data entered is appropriately encrypted. Lending Club ensures that all sensitive personal and financial data is stored in a highly secure environment.

Conclusion

Creating a Lending Club account is very easy and can be done in about 5 minutes. I have not done any lending yet, but when I do I will write a review. Until then, Jonathan at My Money Blog has written a few times on his opinions of Lending Club. Again, if you are interested in giving Lending Club a shot and are interested in a $50 sign-up bonus either leave a comment or email me at pfstartup at gmail dot com.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS

mr_1_468x60


Increased 2009 401k Contribution Limits

January 14, 2009

In developing a plan for my 2009 goals, I stumbled upon some changes to the 401k contribution limits in 2009. I currently don’t participate in my company’s 401k, but I set up a Vanguard Individual 401k for my self-employed income. Depending on my level of self-employed income in 2009, the following changes may affect my maximum contribution amount.

2009 401k Contribution Limits

The 2009 salary deferral contribution is limited to $16,500 if you’re under 50. If you’re over 50, the 2009 salary deferral contribution is limited to $22,000 ($16,5000 plus a $5,500 catch-up contribution). This results in a $1,000 increase in the salary deferral contribution and a $500 increase in the catch-up contribution when compared to 2008.

Total contribution limits also increased for 2009. If you’re under 50, total annual contributions (salary deferrals and employer contributions) max out at $49,000, which is increased from $46,000 for 2008. If you’re over 50, total annual contributions max out at $54,500, which is increased from $51,000 for 2008.

Individual 401k Maximum Contribution Limit

My Individual 401k maximum contribution limit is roughly calculated in the following way (for a sole proprietor under the age of 50):

  • If you’re net income is less than the salary deferral contribution limit ($16,500 for 2009) you may contribute your entire income reduced by 1/2 of your self-employment tax.
  • If your net income is greater than the salary deferral contribution limit, you must calculate your net compensation.
  • Net compensation is net profit from IRS Form 1040 Schedule C with 1/2 of your self-employment tax removed.
  • As a sole proprietor, you may contribute up to 20% of your net compensation in addition to the salary deferral contribution with a maximum value of $49,000 in 2009.

A plan contribution calculator from Vanguard can be found HERE.

Conclusion

Although I doubt I will earn enough self-employed income to reach the salary deferral limit, it’s always good to know what the limit is so you can plan accordingly. Between maxing my Individual 401k and my Roth IRA contributions, I have a lot of work ahead of me for 2009.

For another resource on the new 2009 401k contribution limits:

Increased 401k Contribution Limits in 2009 by Cash Money Life.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS

mr_1_468x60


2009 IRA Contribution Limits

January 13, 2009

I just published my goals for 2009. One of which is to max out my Roth IRA. The best way to achieve any goal is to plan. In doing my planning I had to look up the contribution rules and limits for 2009 to see if there were any changes from 2008’s contribution limits. The 2009 IRA contribution limits are as follows.

Traditional IRA Contribution Limits

The contribution limits did not change for 2009 as you can contribute up to $5,000. If you will be 50 years old by December 31, 2009 your contribution limit is $6,000. As a married couple, the contribution limits are effectively $10,000 and $12,000 as both you and your spouse are eligible for a traditional IRA.

Traditional IRA contributions have no income limitations, however, there are income limitations for deducting the value of the contribution.

Traditional IRA Deduction Limits

Deduction limits only apply if you are covered by an employer retirement plan. These deduction limits have not changed in 2009. If you’re unmarried, your contribution deductibility begins to phase out if your adjusted gross income (AGI) exceeds $53,000 and completely phases out at $63,000. If you’re married and both you and your spouse is covered by an employer retirement plan, your contribution deductibility begins to phase out if your joint AGI exceeds $85,000 and completely phases out at $105,000.

It gets slightly complicated if only one spouse is covered by an employer retirement plan. For the covered spouse, the contribution deductibility begins to phase out if your joint AGI exceeds $85,000 and completely phases out at $105,000. For the non-covered spouse, the contribution deductibility begins to phase out if your joint AGI exceeds $159,000 and completely phases out at $169,000.

Roth IRA Contribution Limits

The contribution limit for a Roth IRA also did not change and is $5,000. If you will be 50 years old by December 31, 2009 your contribution limit is $6,000. As a married couple, the contribution limits are effectively $10,000 and $12,000 as both you and your spouse are eligible for a traditional IRA.

As opposed to the traditional IRA, the Roth IRA has income limitations for contributions. The income limitations have changed for 2009 so take note. For unmarried individuals, the contribution limit begins to phase out with an AGI of $105,000 and completely phases out at $120,000. For married individuals, the contribution limit begins to phase out with a joint AGI of $166,000 and completely phases out at $176,000.

Conclusion

Even though 2008 is officially in the books, you can still contribute to a 2008 IRA up until the tax filing deadline of April 15. After 2009, the IRA contribution limits will be indexed to inflation, which will make IRAs very powerful investment vehicles.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS

mr_1_468x60


Surviving The Economic Downturn With A Long-Term Outlook

November 19, 2008

The economic downturn that has dominated the headlines for the past few months has severely diminished the retirement savings of hardworking Americans. Not even President Elect Obama’s promise for change has prevented investors from fleeing the stock market. Government bailout plans have failed to jump start the economy. Unemployment rates are rising and at least one major retailer has filed for bankruptcy. Despite all of the doom and gloom, I’m still anxious to invest in the stock market (once my solo 401k is open). Even though the immediate future is bleak, a long-term outlook can do wonders for surviving the economic downturn.

Time Is On My Side

As a recent graduate, I am just beginning my investment journey. This is the first economic crisis that I have experienced as a member of the working class. I keep telling myself that I have to maintain a long-term outlook and not let the current state of affairs affect my investing plan. To keep pace with my long-term investment plan I will be attempting to max out my soon to be setup solo 401k and my Roth IRA for 2008. I am looking at this economic downturn as an opportunity to buy stock at bargain basement prices. The stock market and economy will rebound, they always have.

5 Year Rule

Due to my limited exposure, I have not lost a lot of money in the stock market. For this reason it’s easy for me to recommend staying the course and even buying more stocks. I am operating under the assumption that you do not have money invested in stocks that you will need within 5 years. It’s a general rule to keep assets that you will need within 5 years in safer funds like bonds, money market accounts or savings accounts. Use this economic downturn as a learning experience to invest only funds that you won’t need for more than 5 years, which requires a long-term outlook.

Time and Risk Relationship

With all of the negative news in the financial world, it might seem like an extremely risky proposition to invest in stocks, however, when you maintain a long-term outlook on investing, the risk is completely eliminated. The graph below shows how the range of annual returns diminishes when you invest over a longer period of time.

risk-vs-timeAs you can see from the graph, the longer you remain invested, the lower the chance you earn a negative annual return. 2008 will definitely fall closer to the bottom of the range for annual returns. Considering over five year periods, the annual return is very rarely negative, let alone severely negative, the stock market must rebound. This argument really only holds true when you diversify your investments (like an index fund), as you can always have negative returns with non-diversified investments.

Thinking Short-Term and Long-Term with Tax Loss Harvesting

Sometimes it is relevant to look at short-term and long-term investment objectives at the same time. An economic downturn provides a prime opportunity to sell losing investments for tax deductions that can be carried over to subsequent years to cancel out winning investments. Selling investments in a down market is a short-term action, however, if the investment has a promising long-term outlook, you can re-buy those investments after 30 days. This allows you to lock in losses for the short-term, yet regain your position for the long-term.

Conclusion

Even though there is nothing but negativity in the financial world, maintaining a long-term outlook towards investing will allow you to come out on top. The stock market always provides positive returns over longer periods of investing, which means the extreme losses will always be followed by extreme gains. Make sure you jump into (or hold strong) the stock market as extreme gains will surely follow this market downturn.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS

mr_1_468x60


New Vanguard Individual 401k For Self-Employed Retirement Savings

November 11, 2008

Previously I blogged about the different self-employed retirement accounts and the different options for opening a solo/individual/self-employed 401k. I’ve been waiting for Vanguard to unveil an individual 401k to begin investing my self-employed income in a retirement plan. I originally heard rumblings of Vanguard launching it’s first individual 401k at the beginning of November. Today was the first day I was able to find any information on Vanguard’s website. I’m pretty excited about opening a Vanguard individual 401k and will do my best to detail the account details and benefits below.

Eligibility

Individual 401ks are available for self-employed individuals such as, sole proprietors and LLCs. This retirement plan will cover the plan administrator, partners and the spouse of the business owner. This plan does not cover individuals with common-law employees such as children. There are also no age and service requirements.

Contributions

Plan administrators set-up an individual 401k plan and administer the plan through Vanguard Small Business Online. There are three types of contributions allowed: employee salary deferral contributions, Roth salary deferral contributions and employer contributions. This means Vanguard offers a Roth individual 401k for those who prefer to invest after-tax money. The Roth individual 401k does not have income restrictions like a Roth IRA. Total contributions for a fiscal year are $46,000 or $51,000 with catch up contributions.

Sole proprietors may contribute up to 20% of net compensation. I am able to defer up to $15,500 as my employee contribution and up to an additional 20% of my net compensation. I will be able to contribute nearly 100% of my self-employed income. I am still on the hook for one half of the self-employment tax.

Investment Options

The investment options are the reason why I have waited patiently for Vanguard to launch an individual 401k. There are over 70 Vanguard funds available for retirement investing. None of these funds have sales commissions. Vanguard is notorious for delivering mutual funds with minimal expense ratios. They also provide target retirement funds and LifeStrategy funds. Target retirement funds automatically move funds from stocks to bonds as you get closer to retirement. LifeStrategy funds vary the ratio of stocks to bonds to cash reserves depending on how aggressive you want to be and how far away your savings goal is.

Account Management

Employers will be able to manage the retirement plan through Vanguard Small Business Online. Employers will be allowed to make contributions, review the transaction history and download forms via this online interface. Employees will have access to account balances and planning tools.

Plan Administrator

A plan administrator must be designated for an individual 401k who must maintain records and submit reports (including Form 5500 when income exceeds a certain level). As a sole proprietor I would be the plan administrator, however, they recommend a co-plan administrator to act in the absence of the plan administrator.

Fees

Vanguard will not be charging an account initiation fee to the employer and there is no minimum investment to open the account. Some funds do have minimum initial investments. Vanguard mutual funds average expense ratios of 0.20%, which is always applied. An account service fee of $20 is required per year for each Vanguard fund in the account. The account service fee is waived when you become a Voyager member (total account assets of $100,000). Only two Vanguard funds charge purchase fees, however, a slightly larger number charge redemption fees if you remove funds within a certain time period.

Distributions

For individual 401ks, the standard distribution penalties and rules apply. If you are under 59.5, you will be subject to taxes and IRS penalties unless you meet certain restrictions. If you are between the ages of 59.5 and 70.5 you are only subject to income taxes. If you are over 70.5 the IRS requires minimum withdrawal distributions. For Roth individual 401ks, the standard distribution penalties and rules apply. If you are under 59.5 years of age or it has been less than 5 years since the first contribution, your money may be subject to income taxes and penalties. If you are over 59.5 years of age, distributions are tax free. At age 70.5, the required minimum distribution kicks in.

Now What

I have to set up my individual 401k by December 31st in order to participate for fiscal year 2008. I still have until the income tax filing date to fund the account for 2008. The website has a link to request a Vanguard individual 401k New Account Application either online or by mail. The link currently is not working. I will call the small business unit of Vanguard tomorrow to request an account application as I have been waiting for awhile to open this account and would like to get the ball rolling so I don’t miss the December 31st deadline.

In my opinion Vanguard is the best place to keep your retirement accounts. I already have my Roth IRA with Vanguard and am thoroughly enjoying the bare bones expense ratios. I’m currently reading Bogle’s book on mutual funds, which hammers home the point of keeping all costs to a minimum, and he certainly follows through on that at Vanguard. I will keep you all updated when I have more information regarding the application process.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS


Investing Basics From Morningstar

October 27, 2008

For what seemed like an eternity, my savings were directed into a money market fund for a down payment on my condo. Now that I have closed on my condo, I will be directing my savings towards maximizing retirement accounts. Currently, I have my retirement assets (Roth IRA) in a Vanguard Target Retirement Fund. I do not have an asset allocation plan because I don’t have enough assets to meet minimum requirements and maintain a diversified portfolio. As soon as I have enough assets to diversify even minimally I will do so. For this reason I will be doing a lot of research on asset allocation and investing in general.

Most of my investing knowledge comes from books that are listed in the right-hand column of the web page and websites such as Motley Fool and Investopedia. I recommend “The Four Pillars of Investing“, “A Random Walk Down Wall Street” and “Common Sense on Mutual Funds” for investing basics.

Recently, I stumbled upon a stellar investing tutorial by Morningstar. Morningstar calls it an investing classroom that focuses on four topics: stocks, funds, bonds and portfolio. The stocks, funds and portfolio catalogs have five different course levels. The bonds curriculum has only two different course levels. In total, the investing classroom offers 172 different courses.

Each course has a mini five question quiz to test your knowledge. If you get enough quiz questions correct you are rewarded with a free 60 day Morningstar Premium subscription.

So far, I’ve completed 66% of the courses on the 400 course level for stocks. I have greatly increased my knowledge of investing with regards to evaluating stocks and accounting. The books that I mentioned above did not really get into individual stock valuations as they mostly recommend index investing. If you’re looking for a great, free resource for stock valuations and individual stock investing check out the Morningstar investing tutorial.

If you like what you have read please consider signing up for automatic updates via e-mail or RSS