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- Entering retirement. Should I go all in on cash or bonds?
- My IRAs are losing money. Should I still make contributions?
- How will COVID-19 affect the housing market?
- What should I do with a $125K windfall?
- Is buying a business a good way to grow my money?
- Retiring soon. Does it make sense to buy a vacation home?
Q1: Entering retirement. Should I go all in on cash or bonds?
I’m just entering retirement, and I’m tempted to go to all cash or all bonds to be safe. I’m still down about 10 percent from the hiccup in March. Is this a smart move?
— John U.
Answered by Stephen Kates, CFP: “As scary as the recent drop in the market has been, taking your assets completely to cash will leave you in the difficult position of (1) having little to no growth on your assets until you reinvest and (2) trying to time when to return to the market. I suggest staying invested in a balanced portfolio of stocks and bonds.
Since the market drop, have you rebalanced your portfolio? One of the most important ways to manage your investment portfolio is to rebalance after significant market movements. You likely saw your stock investments fall in value while any fixed income you have likely didn’t move nearly as much. If your asset allocation is different from your target allocation, you should adjust it to bring it back to your target allocation.
If you feel uncomfortable returning to your prior allocation pre-coronavirus, you could reduce your stock exposure, but this will lengthen the time you will need to recover your lost value and slow down your long-term growth. If you have a solid emergency fund to use as a cushion (for retirees, I suggest 6-12 months of expenses), continuing to invest will give you the necessary growth throughout your retirement to keep up with inflation. Today is only the beginning of your retirement journey, and it often lasts for many decades. Growth now is just as important in retirement as it is pre-retirement because although you are planning to use this money for income, you need to also continue to invest it for years to come.”
Q2: My IRAs are losing money. Should I still make contributions?
I have a traditional IRA and a Roth. Considering both are just treading water in today’s economy, should I continue to put monthly contributions into those accounts when I see them losing money?
— Michael Mi.
James Royal, senior investing and wealth management reporter: “It sounds like you have your money invested in stocks or bonds, rather than holding cash in your IRA. If that’s the case, it can be stomach-churning to see your investments fall as the market gyrates. But tax-advantaged accounts such as IRAs offer a great benefit in helping you save for retirement, and you won’t be able to make any further contribution for a tax year once the tax-filing deadline runs out. So you have limited time to take advantage of it.
If you don’t feel comfortable investing the money today, that doesn’t mean you can’t still take advantage of the tax benefits today. You can still deposit the money in the account but leave it as cash and then invest it later. A Roth IRA may be an especially good option here, because it allows you to withdraw any contributions later without a tax penalty, if you have another pressing need. That said, the traditional IRA may get you a tax break today, saving you some extra money. But the key point is this: Because of the time limit on your contributions, you can’t get the tax advantages unless you deposit the money. Finally, while it’s not clear how you’ve invested, take a look back at the performance of the S&P 500 index over the past 30 years or so. While the index has dipped – sometimes nearly 50 percent in less than a year – it’s continued to climb over the long term. If you’re investing, you need to think at least five years out and adjust your expectations to that reality. Otherwise, you may be likely to sell just when the market is at a low.”
Q3: How will COVID-19 affect the housing market?
How will COVID-19 affect the housing market over the next year? Will we see a decrease in valuation as forbearance agreements and unemployment hammers our economy? Or have enough measures been taken to protect the housing market, continue driving demand and appreciation of home values?
— Erick D.
Answered by Jeff Ostrowski, senior mortgage reporter: “You pose a trillion-dollar question, one with no clear answer. The U.S. housing market has held up remarkably well since the pandemic hit. Demand for homes has fallen, which is a predictable result of a spike in unemployment. However, the supply of homes for sale has fallen even farther, as homeowners have decided not to sell. The short-term result has been a continued rise in home prices, along with bidding wars in some markets. Many housing experts say the pandemic has created fresh demand for housing — those who can afford it are shopping for bigger homes.
While the housing market has seen a long run-up in valuations, the latest housing boom serves up nothing like the frothy conditions — overbuilding, loose lending standards — that led to the Great Recession. During the past decade, housing starts were tepid, lenders were strict and homeowners amassed a large equity cushion. All of that acts as a shock absorber for the housing economy during this bumpy ride. Of course, the path of the economy and the trajectory of the pandemic are unpredictable. A continued resurgence of COVID-19 cases, or a spike in unemployment, would act as a drag on housing prices. And it’s worth remembering that housing markets are intensely local: Areas such as Las Vegas, Honolulu and Detroit have been hit especially hard by this recession, and values could take longer to recover there.”
Q4: What should I do with a $125K windfall?
I have my retirement accounts in good shape and a six-month cushion for emergencies. My job is reasonably secure, and I expect to work for about 12 more years. I now have about $125K in cash that I need to deal with. I’m reasonably familiar with safe savings investments and know something about self-directed brokerage accounts, but I’m not sure what makes sense. I don’t mind risk, but I don’t want to bet the entire amount on something crazy. What are your thoughts on dealing with this windfall?
— Michael Ma.
James Royal, senior investing and wealth management reporter: “Congratulations on having your financial house in order and then thinking about what makes sense for your windfall. How long is your time frame? Is it the full 12 years you expect to work? If you’re looking to access the money in less than three years, your best option is likely an FDIC-backed CD, which offers you a return with no risk that you’ll lose your principal, up to $250,000 per bank.
If you’re able to go the full 12 years without accessing the cash, then you have the potential to generate more interesting returns. Superinvestor Warren Buffett recommends that investors looking to build wealth in the stock market turn to an S&P 500 index fund and then continue to hold that for the long term. Yes, stocks can be volatile, as we’ve seen this year, but by investing for the long term, you’ll be able to ride out the market’s short-term dips. Over long periods, the S&P 500 has returned about 10 percent annually to investors – but only if you held on through the tough times. The index is well diversified, holding hundreds of America’s best companies, and is about the safest way to invest in stocks. That said, if you want further diversification, it could make sense to add some bonds to that mix, which will make the overall portfolio less volatile and provide you more income.
It can be tremendously helpful to consult a financial adviser on these issues, but you’ll need someone who’s looking out for your best interests – here’s how to find one – and who helps keep you on the right track over time.”
Q5: Is buying a business a good way to grow my money?
I would appreciate your advice relevant to me in two finance matters:
- I quit a job at the onset of COVID-19 early this year and have $70,000 in my 401(k). It hasn’t been managed since then because I don’t know what to do with it. Sadly, it depreciated a significant amount recently.
- I have $200,000 I am thinking of using to buy a business, such as an existing one or franchise. However, are there better options to grow my money either for the short term (while everything is on furlough) or for the long term?
Thank you for your expert advice.
— Erwin A.
James Royal, senior investing and wealth management reporter: “As you assess your future directions, you’ll want to consider a few alternatives. While being your own boss may sound like a dream, it comes with increased risks, too. Small businesses are notoriously risky, with a high failure rate. However, if you have the right skills and expertise, you can make a go of it. But you ought to at least consider the value of diversification. If you use your cash to invest in a business, then your whole financial life revolves around the success of that business. If it fails, not only are you out of a job, you may deplete your whole savings in the process.
However, if you find another job and invest your money in a diversified portfolio including stocks, you have two potential sources of wealth creation. A well-diversified portfolio of stocks, such as an index fund based on the S&P 500 index, should grow over time. Historically, the S&P 500 has grown about 10 percent annually over long periods, but with significant volatility in the interim. While this is the approach proposed by superinvestor Warren Buffett, you must have a long-term mindset to invest in stocks and be willing to keep your money in the market for at least five years in order to ride out the volatility.
For short-term money, your best bet is a CD, and an FDIC-backed account will offer you a safe, albeit low, return. It sounds like it could be helpful to meet with a financial adviser to get your financial life in order and figure out where you can go from here. Here are my top tips for doing that.
Q6: Retiring soon. Does it make sense to buy a vacation home?
I’m a fairly healthy, 65-year-old single woman with a fairly stable job. I anticipate working for another two to three years. I’ve recently become debt-free and own my own co-op, which is worth about $700K with no mortgage. I have a six-month emergency fund. I have a 401(k) worth a little more than $1.8M and an IRA worth about $240K.
I would love to buy a vacation home. I love the idea of a house, but I’m a single woman who is not handy. I recently saw a property I liked for $425K. Is it financially foolish to take $300K from my 401(k), use $225K for the down payment and use the additional $75K for minor renovations, if necessary? Factoring 3 percent 30-year and 15-year mortgages, plus other monthly housing costs, my monthly housing cost alone would be in the neighborhood of $3,500 to $4,500 a month, about 50 percent of my take-home pay.
Also if for some reason I am forced to retire earlier, I will not take Social Security until I turn 70 but will live off my 401(k) and a $3,800 a month pension.
Am I being unrealistic?
— Marilyn M.
Answered by Stephen Kates, CFP: “Congratulations on having saved so well and being debt-free. That is a huge accomplishment! However, taking on a mortgage at this stage of your life will put you back into debt and leave you with much less cash flow. A 15-year mortgage will be paid off when you are 80 years old. This is a potential situation that you should weigh carefully. Before we break down your current cash flow and investments, it’s worth thinking about if you want to commit to a debt payment in retirement. Without knowing all of your current and future expenses, it’s hard to predict whether you can comfortably accommodate these additional expenses. Sustainable cash flow will be your new paycheck once you are retired and the higher your expenses the more of your paycheck will be spoken for.
Based on what we do know, the first consideration will be the withdrawal of $300K itself. For an after-tax lump sum of that size, you would need to withdraw approximately $460K to account for 35 percent federal taxes (more if you live in a state with its own income tax). Any withdrawal you take from your retirement account will be viewed as ordinary income by the IRS and therefore push you into a much higher tax bracket. By withdrawing that much from your investments, you would be depleting your investments by close to 25 percent and paying a lot in taxes. While your investments may still grow between now and retirement, it’s not a guarantee that you would make up that amount before retirement.
Second, it’s important to think about your cash flow needs. Your current balance minus the down payment ($2,040,000 – $460,000) would leave you with $1,580,000 in investments. Assuming a normal 4 percent withdrawal rate in retirement, you could expect to withdraw $5,260 pretax, or $4,000 after tax. Accounting for an expected $2,100 in Social Security, and your pension, this totals roughly $9,000 in monthly income after tax. Based on the estimated housing expenses you predict, you would still be using 50 percent of your take-home income. This is a high amount to be dedicating toward housing, especially in retirement. Keeping your housing expenses under 30 percent would be a more prudent level.
If you are committed to a vacation home, is there a way to lessen your housing costs though rental income or selling your co-op for a smaller primary residence? This could put you in a more stable position to balance two homes.
Having said all of this, my suggestion is that you take stock of all of your income, assets and expenses and work with a financial adviser who can do a proper assessment of your situation. You have done an excellent job saving and have a very solid situation but owning both your co-op, and a second home could leave you in a tight cash-flow situation.”