Friday, October 15, 2010

The Only Guide You'll Ever Need for the Right Financial Plan...

The book of the week was The Only Guide You'll Ever Need for the Right Financial Plan by Larry E. Swedroe. That is quite a mouthful... It's a pretty good book. It is jam packed with information too, and it explains everything with just the right amount of detail.

I think what I'll do is a couple small segments on things that Swedroe writes about. Let's go ahead and discuss Active vs. Passive Management, Roth vs. Traditional IRA, and College Savings Plans. All things things are more thoroughly discussed in the book. I'm just going to do my regular cliff-notes version.

Active vs. Passive Management

If you are a regular reader, you probably know where I stand on this issue. Passive Management is the best way to go hands down! Active Management means that you have a person actually picking stocks and trying to beat the market, it is still spread across lots of securities, but again, someone is trying to beat the market picking and choosing.  Passive Management is run by a computer that distributes stocks across whatever portion of a market you invest in.... for example the American Beacon S&P 500 Index  is a blend of the S&P 500 index. This passively managed index fund will automatically readjust when the market changes.

Actively managed funds are more expensive because you have to pay more for the fund managers 'expert' advise. And since passively managed funds are ran by a computer, there is a much lower expense ratio. To show a comparison. The passively managed fund above has an expense ratio of .15% (pretty typical of passively managed funds). The average actively managed fund has an expense ratio of 1.5%. That means that if you invest in an actively managed fund, not only does it have to beat the market (which is what a passively managed fund represents) but it has to beat the market by 1.35%. And over the long-term, only 5% of actively managed funds can beat the market. And in the short-term only 50% can beat the market. The choice should be pretty simple given the facts... don't let Wall Street sell you on what you don't really need.

Roth vs. Traditional IRA

Again, a lot of you know where I stand on this issue as well. I stand by Roths vigilantly. Roth IRAs are accounts that you invest in after taxes have already been assessed on your income and when you take the money out, when you retire, you take the money and all the interest earned tax free. Traditional IRAs are accounts that you invest in before taxes and you get taxed once you withdraw the money including any interest it accrued, again at retirement. The idea of going one way or the other is where you will stand with your tax bracket when you retire compared to where you are now. Most people think that when they retire they will be in a lower tax bracket because they will not have much in terms of income when they are retired. I think that logic makes sense if nothing changes within the US monetary policy or inflation for the next 40-50 years. But if you look at historical trends, taxes have steadily increased. In the 1950s income taxes were between 1-6% and now we are looking at anywhere from 25-33%. I think given historical trends that taxes will more than likely increase in the next 40-50 years. That being said, it would make more sense to invest primarily in a Roth.

I do however, think that it makes complete sense to invest in a 401(k) if your company offers any type of match. If it were me, I would max out the matched amount by my company and then put everything else into a Roth... potentially maxing out the Roth- which as of 2010 is $5000.

College Savings Plans

If you want to put away money for your kids college and achieve some tax benefits today it makes sense to invest in some sort of college investment account. But what kind??? Swedroe does a wonderful job in this book explaining all the different types of college savings types and the pros and cons associated. The one that makes the most sense financially is a 529 plan... pretty much every state has these plans now. However, I also like Coverdell Education Savings Account. The 529 plan is awesome because the federal government doesn't count it toward the parent or the students finances when figuring up the EFC- expected family contribution. The EFC is a magic number that says how much money you can receive in federal financial aid. The federal calculation is that the child's assets are treated as different than the parent's. The child must contribute 20% of his or her assets each year towards expenses and the parents must contribute 5.6% percent of their total assets. So... If the 529 plan doesn't count toward either of their assets, it makes the student look more favorable to receive money from the federal government. The Coverdell Account is great because it is a tax-advantage account like the 529 plan, but it can be used for educational expenses for grades K-12 as well as college, not just college like 529. So... it's a nice way to save yourself some tax dollars. The only down side to a Coverdell is that there is a $2000 cap per year per beneficiary.

Alright... Well I hope I gave you guys some good information from this posting. The book has a lot of information and although I don't agree with all of Swedroe's opinions on investing I agree with most and I learned a lot from him. This book does a good job living up to it's title. As always, if you have any questions on the book don't hesitate to ask. I would be more than happy to help anyone that wants it.

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