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My Two Cents

Star Tribune column

Chris Farrell Aug 6, 2007

I do a monthly column for the Star Tribune. The paper doesn’t archive it. So, I’ll try and remember to post it when it comes out. Here are the last two columns.

1) Q: …Not too long ago, the company I worked at was a casualty of the mortgage/housing bust. Now, I had worked there for a couple years and had accumulated around $50k in 401(k). Now, would I be better off rolling all that over into my new company’s plan or leaving it out there on it’s own and starting a new 401(k) from scratch at my new job? Also, if indeed I should roll that over, is it tax free? I’m 27 years old if that means anything…. Sincerely, Jeff

A: A big advantage of defined contribution savings plans like 401(k)s and 403(b)s is their” portability”. In other words, you can take the money with you when you leave your job. Although many employers will let you keep the money in their plan even though you are no longer on their payroll, I think your right to take control of your retirement money. There are no tax consequences so long as the money is transferred from your current employer directly to your new employer or into a rollover IRA account. It’s easy to do–all you have to do is fill out some forms

Sad to say, far too many workers withdraw some or all of their accumulated retirement savings when they leave work, perhaps to pay down credit card bills or to fund a move to a new job. It’s understandable, but it’s a terrible financial move. You’re liable for income taxes on any withdrawn money if you are under age 59 ½; you’re subject to an additional 10% penalty tax; and you’ve robbed your retirement savings.

Now, to your specific question about where to put the money, I would first check out the investment options in your new employer’s 401(k). If you really like the plan options, go ahead and deposit the money into the new 401(k) (assuming your new employer allows the transfer). But for many people it makes sense to opt for a rollover-IRA. The reason is that you get to chose the investment company and investment options, not your employer. For example, some 401(k) plans don’t offer broad-based equity index funds. A rollover-IRA gives you a chance to add index funds to your overall retirement portfolio.

Q: Is a REIT index fund a good way to diversify a portfolio invested mainly in stock index funds? How do they perform relative to the general market? What is the prognosis for them? Fred

A: Diversification is among the most celebrated concepts in modern finance. Economist Harry Markowitz won a Nobel prize for turning your grandparents’ admonition–don’t put all your eggs in one basket–into mathematical equations. Diversification reduces investment risk and increases the odds that you’ll earn a decent return over time.

For most of us, the main assets are stocks, bonds, cash, and international securities. But institutional investors have long added another major asset class into the mix: commercial real estate. Long-term studies suggest that the returns on commercial real estate have little relation to those for stocks, making property a terrific diversifier. But owning commercial real estate is out of reach for most individual investors. That’s why reits–real estate investment trusts—are appealing. Reits are investment pools that own and run hotels, office buildings, and other commercial real estate. Their shares are bought and sold like any other stock. These publicly traded stocks distribute at least 90% of their taxable earnings as dividends to shareholders.

To be sure, the evidence suggests that reits are not a distinct asset class like property. Instead, they behave more like a stock exposed to the commercial real estate business. Like any equity, valuations are sensitive to cash flows, management strategy, and investor sentiment. Nevertheless, you’ll gain a stake in a dynamic business and pick up some extra diversification. And I like the broad-based reit index funds because fees are low.

At the moment the reit business is going through a tough patch. The stock group had put on seven strong years, but lately stocks have taken a hit, largely reflecting concerns about the turmoil in the subprime mortgage market affecting reit valuations. In addition, the industry has enjoyed a wave of mergers and acquisitions and takeover activity may flag with the rising cost of credit. Nevertheless, reits are a good addition to a well-diversified portfolio.

Q: I have a medical bill that went to collection agency because my insurance refuse to pay for it. It has been with the collection agency for two years. I just contacted them and they promised to remove it from all credit bureau agencies if I pay it in full including the interest rate. I agreed and when I asked them to send me a letter stating our agreement they refuse. So all we have is verbal agreement, and I am skeptical. I was wondering if you could advise me on this one. Thank you very much.

A: Get everything in writing. A verbal deal is not a deal. When you have negotiated a deal bargain get everything in writing. Then you have a paper trail if there are any disputes. There are several good sources of information to learn your rights with debt collectors. Among them are: the Federal Trade Commission at www.ftc.org, Privacy Rights Clearing House at www.privacyrights.org, and the self-help legal publisher Nolo at www.nolo.com.

2) Q: Our mortgage company proposed making a payment 2 times a month rather than monthly. My concern is, what is in our best interest?… We are retired but working part-time…. Kathleen.

A: The benefit of a program like this is by churning out two payments a month you end up making 13 monthly payments in a year (rather than 12). This shortens the life of your mortgage and lowers the overall cost of owning your home.

That said, I’m not a fan. Lenders charge a fee for setting up the payment program. But you can do this on your own without paying a fee so long as there aren’t any prepayment restrictions in your mortgage contract (and there usually aren’t). Another advantage of the do-it-yourself approach is that it maintains your financial flexibility in case you face an unexpected expense or you’d rather set aside some extra money into money market mutual fund or comparable savings vehicle.

Q: “Struggling artist” is one of those stereotypes that make me cringe, but sometimes the shoe fits. I’m a 35-year-old professional musician who earns $18-22,000 per year, and although it’s not a big income, I am grateful to be making a living in the arts. But the charm of my efficiency apartment wore off long ago, and I dream of buying a home where I can practice without the neighbors hearing me through the walls. Is home ownership even an option for someone in my income bracket? Where can I find resources to help me make this dream a reality? Thank you! Kris

I don’t think owning a home is out of reach for you. For one thing, the housing market should work in your favor over the next few years. To be sure, home prices aren’t down much over the past 18 months, but the market is swollen with inventory and even relentlessly optimistic industry cheerleaders are conceding that the downturn could last for a considerable period of time. For instance, the head of Countrywide Financial, the nation’s largest mortgage lender, recently remarked that he doesn’t expect a recovery until 2009. A reasonable forecast is that the housing market is likely to stagnate for quite sometime following the incredible run-up safe of recent years.

I’m aware of several programs in the Twin Cities geared toward aiding the low-to-moderate income first time homebuyer. For example, the CityLiving Home Program offers assistance to qualified buyers with their mortgage financing as well as down payment and closing cost help. You can learn about the program in St. Paul at www.ci.stpaul.mn.us/depts/ped/cityliving and in Minneapolis at www.ci.minneapolis.mn.us/CPED/city_living.asp. Another resource is the Home Ownership Center (www.hocmn.org). It offers a menu of education and support services for people who want to leave their renting days behind. CityLiving and the Center are linked to other similar programs. Both are good places to start your research.

Art may make life worth living, but as you say the financial odds against many aspiring artist is steep. And you don’t want to end up in financial trouble or even facing foreclosure, which has happened to far too many people in the Twin Cities and elsewhere in the country. When it comes to making the transition from renter to homeowner, the concern is less what you make and more how reliable is your income So, although you probably already do this, it’s important to remember that you’re an entrepreneur, a small business person There are many ways for entrepreneurs to sensibly pay themselves and build up a cash cushion. If you’re looking for some tips, check out a book by Caroll Michels, How to Survive & Prosper as an Artist (5th edition). It’s geared more toward fine artists than musicians, but much of the advice would be the same.

Q: I have 2 annuities at TCF – 1 is approaching the surrender date, the other has a year left to go. I went into TCF to look at my options, mainly I want to close the annuities at surrender date and re-invest in something like a savings certificate (CD) at a higher rate at a different bank. I know annuities are tax deferred and CD’s are not, however TCF is telling me that if I don’t re-invest into another annuity but rather put it into a CD or something, I will be taxed on the interest earned from the annuity – That I understand if I just take the money and use if for whatever, but my argument is that if just re-deposit into another investment, then taxes aren’t an issue. (I would have the check payable to me, but take that check and hand it over to the bank of my choice when I open a new CD). So, I need some clarification on this – It has been my personal understanding that as long as I don’t touch the money, but re-invest into another investment (like a CD) I avoid having to pay any kind of taxes. Who is right in this situation?…. Thanks. Mark.

A: Ah, the joys of our tax code. Yes, in both cases you are looking to set aside the money as a long-term investment. But the products are treated differently by the tax code. You would end up paying taxes moving your money from the annuity to a CD.

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