The 5 Reasons Why I am Gradually Moving More of My Money to Exchange Traded Funds

In the recent months I have begun moving more and more of my money to index funds/exchange traded funds. Below I list the 5 main reasons why I have chosen to do this.

1. Picking Stocks Takes Time

I love researching and picking my own stocks, especially when they turn out to be big winners. However, in order to pick the right stocks it takes time and patience.

When I pick stocks I am very meticulous in my research. I only pick stocks that appear to be a great companies at a good value.

Finding these stocks takes time.

In order to free up time for my other ventures, I have begun investing more and more into exchange traded funds, also known as ETF’s.

2. My Chances of Beating the Market are Slim

I know that the chance of me beating the market as a whole is slim. While I love researching and picking stocks, it is highly likely that my returns will be subpar, or right at the market at best.

Instead of hoping to match the market and maybe beat it, I have instead chosen to invest my money into the very funds I am trying to beat.

This goes hand in hand with #1 listed above. Why spend so much time matching the market when I can buy an ETF in the market?

3. Diversification is Simpler

Trying to diversify a portfolio with many stocks can prove to be a difficult challenge. This is another reason I have chosen to invest more in ETF’s.

Consider this: I have one Total Stock Market ETF and on Total Bond Market ETF. It is much easier for me to balance this portfolio than if I am juggling with 20 different stocks and bonds in my portfolio all at one time.

4. Keeping Track of Stocks Takes Time

I noted above that picking stocks takes time, but tracking your own stocks takes even more time.

In order to maintain your portfolio, you need to have some idea of how your stock positions are performing.

So you need to stay updated on the stock’s news and know when a good exit point for you will be.

I have lost out in some instances where I waited too long to sell a stock. As a result, I am still holding some stocks that have proven to be losers which brings me to #5.

5. It’s Hard to Cut Losses

With individual stocks it is hard to cut losses and move on. This is something that I have struggled with.

I currently own some stock in 3D Technology (DDD) which has dropped 39% since I bought in about a year ago.

What is holding me back?

If I had to guess, it would be the loss aversion theory in action. I wrote a post about loss aversion which you can check out here.

Do you pick your own stocks or do you opt to invest in an exchange traded fund instead? Why did you choose one over the other? 

Advertisements

First Time Investor: What do I do?

I was recently talking to a family friend about his finances. He seemed very interested in getting started in investing money. Keep in mind, the family friend is turning 30 this year built up an emergency fund and is now looking to invest $3,500.

On top of that, the family friend does not know anything about investing. Now, I could have gone on and told him about IRA’s, 401(k)’s, and individual brokerage accounts, but I knew two things would happen:

  1. He would get bored with what I was saying and just want me to tell him what to do
  2. I would overwhelm him and he probably would put investing on the backburner for a while until he was able to “figure it out.”

Getting Started

So, what I told him was that it was very simple to sign up. All he had to have was a computer, over $3,000 in his bank account, and his estimated retirement age. With all of this available, he would be well on his way to building his retirement account.

The very first thing I suggested to him was to sign up for an account at Vanguard. He didn’t ask why, but if he did I would have told him this: Vanguard charges the lowest fees of any other mutual fund provider. Lower fees means more money in your pocket when you retire.

So, he signed up for an account at Vanguard. The next thing I had him do was sign up for a Roth IRA account. You can read more about why you should always choose a Roth IRA here.

Account ready and Roth IRA set up, he deposited his $3,500 into his Vanguard account. Then he asked me “What should I invest my money in?” Once again, I could have gone on a tangent about exchange traded funds vs. mutual funds and asset allocation, but I skipped the lecture.

I asked him, “When do you plan on retiring?”

He responded, “I don’t know, maybe around 60 I guess?”

“Okay, that’s all I needed” I told him.

I showed him Vanguards mutual funds, filtered “Asset Class” for “Balanced”, selected “Target Retirement 2045” and we were done. He has just made his first investment into a wide variety of stocks and bonds which automatically balances over time based on his risk profile, without him ever having to lift a finger.

Do you want to get started?

If you are a newbie just getting started with investing, picking a “Target Retirement” dated mutual fund is the simplest way to get started.

All you have to do is figure out your target retirement date, subtract your current age, and add that to 2014 and you will know exactly which fund to invest your money in.

If you are 24 years old and plan on retiring at 65, your Target Retirement date would be 2055. Viola! You are done.

Now that you know what to do, here is why you are doing it

Target Retirement date mutual funds are attractive for a number of reasons:

1. They automatically balance your portfolio for you.

You already know that you don’t want to put all of your eggs in one basket. By investing in a Target Retirement date account, you are investing in a wide variety of stocks and bonds, and effectively spreading your dollar out everywhere. This limits your risk of loss because of diversification.

2. As you get older, your investments become less risky

When you get closer to retirement, the last thing you want to worry about it giant fluctuations in the stock market destroying your investments. Target Date mutual funds become less risky as you move closer to your retirement date, making it less likely that you lose money. As a result, you will have a more stable, predictable income stream in retirement.

3. They are extremely simple to set up and manage

With Target Retirement mutual funds, you literally do not have to do anything at all except put money into the account. Every month you invest your savings into these accounts, and everything else is all taken care of. This is ideal for those who don’t know much about investments and do not care to learn about investments, but still want to retire comfortable.

That’s it!

There you have it. You just set up a retirement account that will do all of the hard work of investing for you. All you have to do is sit back and wait to reap the benefits.

SEP IRA Rules and Contributions: What you need to know

What is a SEP IRA?

A SEP IRA is short for a Simplified Employee Pension Individual Retirement Account. It is basically an IRA account which employers have the ability to contribute to. Employers benefit from having an SEP IRA because it is easier to set up than a 401(k) and also costs less to administer.

Who is eligible?

All employees are eligible are long as the meet these three requirements:

  1. At least 21 years old
  2. They have worked for the employer at least three of the past five years
  3. They have received compensation of $500 or more for the tax year

As a result, any employee who meets these three requirements must participate in an SEP, even if they are only part-time, seasonal, were laid off, fired, etc., during the year.

Why would you want to choose a SEP IRA?

SEP IRAs are must easier to set up than a 401(k). It is basically the same as setting up a regular old investment account. Start up and maintenance costs are also very low when compared to 401(k) plans. Contributions are discretionary, so the employer can decide if they want to contribute to the retirement plan that year. SEP contributions and Traditional IRA contributions are completely separate. That means the employer and employee can contribute to the same IRA account, and the limits applied to the two accounts do not affect one another. A SEP is a very attractive option to a small business owner that wants to provide a retirement account to employees at a low cost.

What are the contribution limits to a SEP IRA?

Employers are allowed to contribute the lesser of 25% of an employee’s compensation for the year or up to $52,000 for the 2014 taxable year. The limit that employers can contribute for themselves is a little more complicated, but it is basically 18.6% of net profit.

What other rules are applicable to a SEP IRA?

The employer must provide the same amount to every employee. For example, if the owner contributes 10% to Sally’s retirement account, they must contribute 10% to every single eligible employee’s retirement account. The last day you can make contributions to a SEP is either April 15th or the extension due date. A SEP IRA is very similar to a Traditional IRA in that:

  1. You can begin to make withdrawals at 59 ½ years old
  2. You must take required minimum distributions at 70 ½ years old.
  3. Funds are invested in the same way as a traditional IRA

Final Word

SEP IRAs are great options for small business owners who are looking to create an employer contributed retirement account for either themselves or their employees.

Why you should always choose a Roth IRA

In my previous post I discussed the difference between a Traditional IRA and a Roth IRA. In this post I’m going to talk about why you should choose a Roth IRA over a Traditional IRA.

What a Roth IRA?

A Roth IRA is a retirement account which allows you to put away $5,500 (after taxes) a year. While these contributions are not tax deductible, a Roth IRA will pay off when you actually do withdraw your money. You see, with a Roth IRA you are allowed to take out your money without paying any taxes! You will get away with paying a 0% tax rate in retirement. What’s better than that?

I want to withdraw money from my Roth IRA, will I face a penalty?

You are allowed to withdraw your contributions from a Roth IRA at any point and time without facing a penalty. Here it is important to differentiate between contributions and earnings. Say you put in $1,000 and earn $50 in interest in your Roth account. You are allowed to withdraw your original $1,000 without facing any penalty! Why is this so wonderful? With a Traditional IRA you are required to pay both taxes AND a 10% penalty if you withdraw ANY money from your account.

In addition, you may contribute to a Roth IRA if you also participate in a 401(k) plan from your employer. While you may also be allowed to contribute to a Traditional IRA, you lose the benefit of deducting a certain percentage of your contribution, depending on your income rate. See the chart for deductions in my previous blog post. With a Roth IRA, you do not have to give up the benefit of tax free withdraws just because you have a 401(k). In summary, if you have a 401(k), open up a Roth IRA to maximize the tax benefits.

Finally, a Roth IRA does not require distributions based on age. You see, when you have a Traditional IRA, you are required to make withdrawals at the age of 70 ½ years old. With a Roth IRA you do not have to make withdrawals. If you are old and have a ton of money stashed away, you are not required to take money out of your Roth. Why does this matter? You will be allowed to let your wealth continue to build TAX FREE after the age of 70 ½, which means your can leave more money to your beneficiaries.

What are you waiting for? Open a Roth IRA today!

Traditional vs. Roth IRA, Which one should I choose?

What is a Traditional IRA?

An IRA stands for Individual Retirement Account. IRAs are held at banks and brokerages and allow you to invest in almost anything you can imagine. The benefit of having a Traditional IRA is that you can deduct your contributions on your tax return.

What is a Roth IRA?

A Roth IRA is very similar to a Traditional IRA. There is one exception: the money you contribute to a Roth IRA is taxed today (you cannot take a deduction on your tax return for contributions), but it is not taxed when you withdraw any money in the future. Therefore, all money you take out of an IRA, included gains on your investments, are not taxed in the future.

How much can I contribute to my IRA?

When you have an IRA, either Traditional or Roth, the most you can contribute is the lower of $5,500 or your taxable compensation for the year. If your taxable compensation is below $5,500, then you will be limited to the amount of your taxable income for the year. If you are over the age of 50, you are allowed to contribute $6,500 to your IRA.

How much can I deduct on my taxes for my IRA?

The amount you can deduct on your taxes depends on one condition: Do you or your spouse (if married filing jointly or separately) have a retirement plan at work? If the answer is no, they you are allowed to deduct the full amount of your contribution to your IRA. If the answer is yes then it can be a bit tricky.

I have a retirement plan at work, how much of my IRA contribution can I deduct?

The following chart is provided by the IRS to help determine how much of your IRA contribution you can deduct when you are provided with a retirement plan at work:

If Your Filing Status Is…

And Your Modified AGI Is…

Then You Can Take…

single or
head of household

$60,000 or less

a full deduction up to the amount of your contribution limit.

more than $60,000 but less than $70,000

a partial deduction.

$70,000 or more

no deduction.

married filing jointly orqualifying widow(er)

$96,000 or less

a full deduction up to the amount of your contribution limit.

 more than $96,000 but less than $116,000

  a partial deduction.

 $116,000 or more

 no deduction.

married filing separately

 less than $10,000

  a partial deduction .

 $10,000 or more

 no deduction.

If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “single” filing status.
married filing jointly with a spouse who is covered by a plan at work

$181,000 or less

a full deduction up to the amount of your contribution limit.

more than $181,000 but less than $191,000

a partial deduction.

$191,000 or more

no deduction.

married filing separately with a spouse who is covered by a plan at work

 less than $10,000

 a partial deduction.

 $10,000 or more

 no deduction.

By utilizing this chart, take your filing status and adjusted gross income, and you can see if you are allowed to deduct the full amount, a partial amount, or no amount.

When can I withdraw money from my IRA?

The IRS allows you to withdraw from you IRA (Traditional and Roth) without any penalties after the age of 59 1/2. If you do withdraw from your IRA before this age you will be hit with a 10% penalty on top of the taxes you owe to the IRS. There are certain exceptions that will allow you to withdraw money penalty free before the age of 59 ½, which I will discuss below.

How can I withdraw money from my IRA without facing a penalty?

  1. You are over the age of 59 ½ you can withdraw money from your IRA penalty free. ‘
  2. You use withdrawals to pay higher education costs for your spouse, your children, or grandchildren.
  3. You can take up to $10,000 (or $20,000 if you are a couple) to buy, build or rebuild your first home.
  4. You use money from your IRA to pay for medical expenses in excess of 10% of your AGI which are not reimbursed during the taxable year.
  5. You become disable and can no longer be gainfully employed.
  6. You die and leave it to an heir.
  7. Roth IRA – You can withdraw your contributions but not your earnings (interest and dividends accumulated) from your Roth IRA at any point in time.

How long can I contribute to my IRA?

If you have a Traditional IRA, you are allowed to make contributions until the age of 70 ½ years old. If you have a Roth IRA, you are allowed to make contributions as long as you are alive.

Should I choose a Traditional IRA or a Roth IRA?

When deciding between a Traditional IRA and a Roth IRA, it could be tricky. With a Traditional IRA you can deduct your contributions in the current year that you make them. This is appealing if you want to lower to tax burden in the current year. You would also want to choose a Traditional IRA if you believe you will be in a lower tax bracket when you are older. That way you limit your tax payments to the lower future tax rate. In addition, you can contribute to a Traditional IRA at any time without income limitations. This differs from a Roth IRA which does not allow you to make contributions if you make over a certain income level.

With a Roth IRA, you cannot deduct your contributions in the current year that you make them. However, you will not be taxed on the money you take out of a Roth IRA in the future. This is appealing if you think you will be in the same or higher tax bracket when you are older. In addition, you can take out your principal contributions at any time without facing a penalty.

When it comes to choosing retirement accounts, take your time. Consult with your accountant or tax professional and make sure you pick the retirement account that best suits your needs.