Whether preparing income taxes or squeezing in last-minute charitable contributions, most financial planning occurs at the beginning and end of the year. But for investors who like to stay on top of their finances, summer gives you some breathing room to focus on the long term. To help get your financial plan in order, BLACK ENTERPRISE outlines four steps to implement midyear.
MAXIMIZE RETIREMENT SAVINGS
The cornerstone of any financial plan is saving for retirement. "Make the maximum contribution to your 401(k)," advises Alfred Osbourne, a senior financial adviser with American Express Financial Advisors in East Meadow, New York. "At the very minimum, max out to the employer match." A 50% employer match is equal to a 50% return on your investment. Where else are you going to find such opportunities?
Putting money into a 401(k) also reduces your taxable income and could place you in a lower tax bracket. Money in these accounts grows tax-deferred until you withdraw, at which point you’ll pay income tax on your withdrawals. You’ll be surprised at how little boosting your contribution will detract from your take-home pay since the money comes out pre-tax.
In 2005, the maximum annual 401(k) contribution increased to $14,000. Those 50 and older can contribute up to $18,000 under a catch-up provision. Patricia Turner, 36, and her husband, James Rice, 43, who live in Silver Spring, Maryland, contribute as much as they can to their employer-sponsored 401(k) accounts. Turner, a laparoscopic surgeon, and Rice, an electrical engineer for the Navy, spent years living on Rice’s salary and accumulating student loan debt.
Since August 2004, the couple, who have a 6-year-old daughter, Jessica, and are expecting their second child in October, have been making up for lost time. "This is the first time that we both have had a retirement account," says Turner. "We’re maxing out my contribution and playing catch-up."
So far, Turner and Rice have managed to squirrel away $125,000 for retirement. Turner saves $13,000 a year, a figure matched by her employer; Rice is setting aside $12,000 into his account, and his employer is matching up to $5,000. They are also funding individual retirement accounts.
REDUCE YOUR TAX BITE
Just because you have to pay taxes, doesn’t mean you should pay more than your fair share. Halfway through the year is a good time to run a tax check. "If you wait until calendar year-end, then there’s nothing that can be done about your taxes," says Jaime Wright, a financial consultant with AXA Advisors in New York. "Midyear is a good time to review your whole tax picture."
This is especially important if you think you might be one of the more than 12 million Americans who will be ensnared by the alternative minimum tax this year. When it was first enacted, AMT was meant to ensure that even the ultrawealthy paid taxes. But now, more middle-class Americans are subject to the tax because it was never indexed to inflation. In 2005, about 15% of people making between $75,000 and $100,000 could end up owing AMT. While it hurts, the AMT allows any tax you owe this year to be used as a tax credit the following year.
You’re more likely to run up against the dreaded tax if you’re like Warren Steele, 42, a retired senior vice president of marketing with AFLAC who receives stock options and claims multiple deductions. To lessen his tax bite, Steele and his wife, Lorie, who live in Columbus, Georgia, defer some deductions and exercise stock options every other year. This forces Steele to pay the AMT every two years. The stock options are a main source of his income.
Another way to reduce taxes is to do some tax-loss selling to offset any potential capital gains. Generally, this is a year-end strategy. But you can employ it now and continue investing in the stocks or bonds you like.
For example, if you own Cisco stock, which is down 11% so far this year, and you sell it to buy shares of Juniper Networks, which is down 17%, you’d wind up with similar computer networking stocks, but you’d also have some losses to offset your tax picture for next year. By law, after accounting for any stock market gains, you can reduce your income by up to $3,000 a year.
"If you trim a little off winners at the end of year, the losses you took midyear give you more flexibility," says Sue Stevens, director of financial planning with Morningstar Inc.
REVISE YOUR ASSET ALLOCATION
Ibbotson Associates, a Chicago-based data provider, suggests that asset allocation is more important than individual stock selection in determining your long-term investment success. Stocks are more volatile than bonds, so the more time you have until retirement, the higher amount of stocks you should have in your portfolio. If you’re in your 20s and 30s, your goal should be to save as much money as possible and make it grow.
Consider Turner and Rice. The Maryland couple recently loaded up on stock funds because they believe they have time to ride out any volatility in order to get a greater payoff. For almost 80 years, stocks have beaten bonds by an average of five percentage points a year after inflation.
If you are in your late 40s and 50s, keeping the money you’ve accumulated is more important. That’s when bonds take on a bigger role. One rule of
thumb to determine your bond allocation is to match it to your age. In other words, a 40-year-old should have an asset allocation of 60% in stocks and 40% in bonds. Each year, the stock portion should fall and your bonds should increase. A more aggressive formula to determine your stock allocation is to calculate: 110 minus your age multiplied by 1.25. With this approach, a 40-year-old should have a whopping 87.5% in stocks and just 12.5% in bonds. Even people in retirement need a helping of stocks.Steele, for example, has 75% of his portfolio in the stock of his former employer, AFLAC. "At some point during my time at AFLAC, I started getting stock options," says Steele. "Unlike some of my co-workers, I kept the stock. I didn’t buy boats or cars with it. And it appreciated a lot in the 1990s."
Letting the stocks grow enabled Steele to retire in his early 40s. Now he spends his days with his wife; 7-year-old daughter, Ariel; and 11-year-old son, Warren III. His overweight in equities should help him stay ahead of inflation while he isn’t bringing in an income. Steele, however, will have to diversify his holdings in the event that AFLAC shares slide significantly. Having so much of his retirement savings in one stock leaves him open to tremendous risk. If that one stock fails, so do his retirement plans.
A healthy stock holding should be a mix of large, medium, and small companies and international stocks. Some stocks will be up while others will be down, thereby smoothing out the ride over the long term. Index funds are a good way to accomplish this goal. Look at Vanguard Total Stock Market Index (VTSMX; 800-662-7447) fund for domestic stocks and Artisan International (ARTKX; 800-344-1770) for international exposure. A low-cost, broadly diversified bond fund, such as Harbor Bond (HABDX; 800-422-1050), can supply your bond fix.
And don’t forget about cash. Experts say a cash reserve of six to nine months of living expenses in addition to your retirement savings is necessary. This way, if you’re hit with an emergency, you won’t have to sell your investments. "I would say that you should be saving 10% to 15% of income, in addition to what you’re doing in your 401(k)," says Gwendolyn Kirkland, a financial planner with Kirkland Turnbo & Associates of Matteson, Illinois.
REBALANCE YOUR PORTFOLIO
Once your asset allocation is in place, stick to it. If you intend to have 20% of your portfolio in bonds, make sure you are staying within that range by rebalancing at least once a year. Neglecting this chore for even a few years can put
your portfolio terribly out of balance. Over the last five years, bonds have returned a cumulative 41%, while stocks posted a 15% loss. As a result, many people now have a higher percentage of their portfolios in bonds than they intended.
Take some time to make adjustments if your portfolio balance is off. "When you rebalance, what you’re essentially doing is selling high and buying low. That’s the crux of the strategy," says Osbourne.
Identify the best performers in your portfolio. Likely candidates will probably be real estate, commodities, and bonds. Prune profits from these holdings so they equal your desired allocation, and add the proceeds to categories that haven’t fared as well, such as large-cap growth or technology.