Interest Going Down, Down, Down; Stocks Up, Up, Up
by Archie M. Richards, Jr., CFP®
November 24, 2003
Estelle writes, "I am 61 years old and plan on retiring next year. My savings are invested in CDs, Savings Bonds, and a few tax-free municipal bonds. How secure are the Vanguard funds you've been recommending, and what are their minimums? I'm in the lowest tax bracket and don't feel I can take the risk of losing any of the principal I've saved."
At 61, Estelle, you probably have many years ahead of you. Vanguard accounts aren't guaranteed, but I expect to see the interest on your savings accounts go down, down, down, while stocks go up, up, up. I hate to see you miss out. Visit www.archierichards.com and go to Past Columns. Read the columns dated 6/30/03 and 9/29/03. Then call Vanguard at 1-800-523-7731 and put your savings into the index funds I suggest. For IRAs, minimums are $1,000. For non-IRAs, they're $3,000.
If you just can't bring yourself to do that, call Ameritas Insurance Company at 800-745-6665 and acquire its variable annuity policy. Invest a portion of your money within the policy into Vanguard stock funds. The policy guarantees that if you happen to die when the value of the account is less than the amount your purchased, the insurance company will make up the difference. The cost of that guarantee is only 0.55 percent.
You say you own tax-free municipal bonds. You also say you're in the lowest income tax bracket. That's 15 percent. Let's say you owned an investment-grade corporate bond. The current yield would be something like 5.9 percent. Reduced by 15-percent tax, you'd end up with about 5 percent. A municipal bond would probably yield about 4.3 percent, tax free. Even after paying the tax, the net interest from the corporate bond would be higher. A switch might be worthwhile. Don't allow your investment choices to be controlled by tax savings.
Don writes, "I maintain two sets of investment allocations. In my taxable accounts, I invest 60 percent in individual equities and index funds, 20 percent bonds, 10 percent REITS, and 10 percent cash. In my IRAs, variable annuities, and 403b plan, the mix is 90 percent stocks and 10 percent fixed income. I'll start tapping into my taxable accounts in a year or two, when I retire. I won't need to touch my retirement accounts for many years, so with those I can be more aggressive - hence 90% in stocks. What do you think about the two asset allocation approaches.
Allocating 90 percent to stocks in your retirement account is okay with me, Don, as long as the volatility doesn't affect you. Over the long pull, stocks perform the best of any sector. The purpose of allocating some money to other sectors is to limit the volatility, to avoid selling the stocks during bear markets. But if the recent bear market didn't give you the urge to sell, I guess you're prepared to remain in when the market turns down in the future.
But why hold 10 percent cash in your taxable account? If you didn't invest the cash in April 2001, September 2001, October 2002, or March 2003, when on earth are you going to do so?
If you're holding cash for a known expenditure that's payable within the next 5 years, put the money into short-term bonds. Don't count it as part of your long-term investments.
For your long-term investment cash, avoid a money market fund. In the long run, short-term rates are going to fall, not rise. Big-time inflation, the main cause of high interest rates, will not return to our shores - probably not for decades. Inflation is caused by bad government policies, and U.S. policies are generally improving. Instead, beef up your share of real estate investment trusts (REITs) to 20 percent of your total portfolios. Since REITs are taxed at higher rates than other stocks, put the additional REITs into your IRA.
Finally, I hope your stock sectors contain foreign as well as domestic stocks. I expect U.S. stocks to perform well, of course, but I expect foreign stocks to perform even better. How about putting half of your stock investments into foreign stocks? It'll pay off.
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