Resource Type: Resource Post

How high fees erode your savings

Posted on June 6, 2020 by -

How fees and investing are related

The science of behavioral economics can help explain why we think the higher the price, the higher the value. There’s a term called “quality theory” that says people often assume a higher price indicates better quality and a higher long-term return on investment.

But it isn’t always the case. Let’s look at how this theory applies to index funds. Index funds are all similar in terms of how they work and how they’re constructed, yet their fees vary widely depending on the asset manager.

Morningstar offers the following example:

A study on index fund fees showed that there are large levels of fee variation among S&P 500 index funds that are virtually identical in most relevant characteristics. RYSPX and SWPPX, for example, are two S&P 500 index funds with a holding similarity score of 99.99 percent. [3]

Over the past 20 years, based on current fees, if you had invested $10,000 in RSPYX you would have paid $4,475.32 in total fees. On the other hand, if you had invested $10,000 in SWPPX over the same period, you would have paid $101.30 in total fees. This massive difference cannot be attributed to differing underlying characteristics because the two funds share almost identical portfolios. Then what explains the difference? Probably a high expense ratio.

Don’t be fooled by “small” fees

One problem that arises when comparing fees that funds charge, is that said fee amounts can appear to be small, with percentages ranging from 0.50% to 1.0% and 2.0%. But these seemingly small differences can make a huge impact on your savings over time.

Make sure to look at the fees you’re paying on the funds you’re investing in. If you realize you’re paying too much in fees, consider making a change.

Compare the funds’ expense ratios

The expense ratio is the annual cost paid to fund managers by holders of mutual funds or ETFs. The expense ratio for mutual funds is typically higher than expense ratios for ETFs. [1]

What is considered a high expense ratio?

What’s reasonable? According to CNN Money, it depends on the kind of fund. Index funds should have the lowest fees because they cost relatively little to run. For example, you can easily find an S&P 500 index fund with an expense ratio of less than 0.2%. For mutual funds that invest in large U.S. companies, look for an expense ratio of no more than 1%. And for funds that invest in small or international companies, which typically require more research, look for an expense ratio of no more than 1.25%. [2]

 

[1] https://tickertape.tdameritrade.com/investing/fund-expense-ratios-17570
[2] https://money.cnn.com/retirement/guide/investing_mutualfunds.moneymag/index14.htm
[3] http://cff.handels.gu.se/digitalAssets/1561/1561456_halling-paper.pdf
[4] All figures in 2012 dollars. Workers are assumed to begin saving at age 25 and retire at age 67. Example reflects median salary of $30,502 when worker starts saving at age 25. Example provided by CAP.

 

Annuities–What you need to know

Posted on June 6, 2020 by -

Annuities: How they work, and what to consider before purchasing one

There are different types of annuities, but in a nutshell, here’s how an annuity works: You give the annuity provider a large lump sum, say $150,000, of your retirement savings. The annuity company takes total control over this lump sum of money and, in exchange, offers you a contract guaranteeing that you will be paid a set amount every month when you retire.

The annuity company pools your money with that of other annuity holders and places it in long-term investments designed to ensure the company’s ability to pay out the monthly sums guaranteed to all eligible annuity holders.

The allure is that you will receive a stable, reliable income in retirement. But there are several catches.

  1. High fees. Annuity companies tend to charge very high fees (3%-4%) on your money while it’s invested with them. These fees are often hidden or applied in ways that are difficult to decipher on a statement. 
  2. It’s difficult to withdraw your money. Let’s say you become dissatisfied with these high fees and want to get your money back to invest elsewhere. Because your money is tied up in long-term, communal investments that the annuity company relies on, they are extremely reluctant to let you take your money back. In fact, they will usually charge you an expensive “surrender fee” if you withdraw your money (between 10% and 15% of your total invested balance). 
  3. They’re not insured. That means if the annuity company goes broke, you can be left empty-handed, with no way to reclaim your money.

The complexity and risk associated with annuities means you should consider all of your options and before moving forward with one. If you do decide to purchase an annuity, it might be a good idea to keep a portion of your retirement savings in a traditional retirement account like your 401k or an IRA.

Stocks and bonds: The basics

Posted on June 6, 2020 by -

Stocks

Stocks are basically a slice of ownership in a publicly traded company. The value or purchase price of that slice, or “share,” fluctuates with the value of the company. So if you own Apple stock, and Apple is doing well as a company, the value of your share in Apple will increase as the stock price rises. Sometimes you will see stock prices rise and fall based on external factors like domestic policies or international trade, but most often, the value of your share is based on company or CEO performance.

In terms of performance, stocks have historically earned the highest returns over time. But they have more short-term ups and downs in price than bonds and are considered a riskier investment than bonds. Because of this short-term volatility, people generally plan to hold stocks as a long-term investment .

Bonds

Bonds, on the other hand, are very similar to traditional individual loans. Just like individuals, companies and governments take out loans to invest in projects or to make large, essential purchases. Unlike individuals, companies and governments may take out these loans by asking the general public to lend them money in the form of a bond. Owning a bond is equivalent to owning a piece of a company or a government’s debt. In return, the company agrees to pay back the initial value of the bond plus interest, just as you might pay back interest on a car or home loan.

Bonds have historically earned lower returns, but those returns are guaranteed and bonds as a whole experience fewer ups and downs than stocks. Because of this, they’re considered a safer investment than stocks.

Which should you buy: stocks or bonds?

You always want to have a balanced portfolio but as you develop your investment strategy, you want to weigh your appetite for risk against the amount of time until you retire. Generally speaking, setting aside a greater allocation for riskier investments with a bigger upside is advisable when you’re younger, because if you lose big, you have time to make up your losses. But if as you’re nearing retirement, you want to shift to safer investments to safeguard the savings you’ve built.

 

Why Asset Allocation Matters

Posted on May 30, 2020 by -

Asset allocation–An overview

The combination of stocks and bonds in your retirement account is known as your “asset allocation.” An example of an asset allocation would be 50% stocks and 50% bonds, or 70% stocks and 30% bonds, or any combination thereof.

A good way to think about different asset allocations is in terms of the risk they carry. When we talk about “risk” in the world of investments, we are fundamentally referring to how much a given investment changes in value over time. 

Some asset allocations can carry more risk than others (such as 100% equity), meaning they are more prone to shift up or down in value, but they may provide a better return over time. Other asset allocations may be more stable and less prone to large swings in value, but they might not grow in value very quickly. Since your needs will change over time (especially as you transition into retirement), your asset allocation will need to change as well.

Why would I use more Stocks or more Bonds?

Stocks, or equities, have historically offered the highest risk and highest returns. But not all stocks are the same. Large-cap stocks are less risky and small-cap stocks have more risk. Investors willing to deal with the volatility of stocks usually realize the best positive returns over time.

Bonds have historically had less volatility than stocks, but the trade off is that they offer more modest returns. There are some types of bonds that are riskier such as junk bonds and high-yield bonds. Investors with a short time horizon often keep their investments in bonds since they offer stability and regular income.

Many mid-career investors prefer riskier asset allocations that frequently shift in value, but have the potential to grow their account value substantially while they have non-investment income. As they get closer to retirement, these types of investors then transition to more conservative allocations.

Are there other factors that influence my asset allocation?

Yes, “time horizon” and, “risk tolerance,” are two main factors that will affect your asset allocation. 

Your time horizon is the number of months or years until your financial goal. Investors saving up for retirement often invest in riskier assets since they have a long time horizon, while a parent saving for a teenager’s college education may stick to less risky investments since they have a shorter time horizon. 

The second major factor influencing asset allocation is an investor’s risk tolerance. In other words, his/her ability and willingness to lose some or all of the original investment in exchange for greater returns. Aggressive investors may be willing to take on higher risk to get better returns, while conservative investors may stick with low-risk investments aimed more at capital preservation.

 

Everything you Need to Know about Icon’s Fees

Posted on May 25, 2018 by -

Overview of Fees

Part of the problem with understanding fees is that there are multiple fees that go to various entities, all of which play a crucial role in your retirement plan. In the case of Icon, we’ve eliminated unnecessary costs and expenses wherever possible.

Let’s start with quickly reviewing the types of fees commonly found in a retirement plan.

Fund Management Fees

These fees can often be the most expensive cost of an account. This is the fee paid to the company that manages the investment funds. This can typically end up being an area where investors get charged large amounts in fees without ever knowing it. High-cost investments and “Dominated Funds” are easily missed by most investors and can lead to large amounts of missed earnings caused by high fees.

Icon’s average fund management fee is 0.08%, while the industry average is 0.79%*. Icon is almost 10 times less expensive.

Plan Administration and Custodial Fees

These fees cover the cost of managing and maintaining your account and include expenses such as recordkeeping, website services, account statements, customer support, etc. All retirement accounts are required to have a custodian that securely holds your savings.

Advisory Fees

This is the cost of receiving advice on how to invest. Advisors can be real people you work with who typically charge you a percentage of your total assets annually. Using a robo-advisor instead of a person can be about half the cost.

Icon does not charge advisory fees.

Icon’s Fees: A Fairer Approach

Most retirement plan providers charge a fee that is based on your total assets. This means that as you make more money, so does your plan provider. This is how fees start to eat away at your savings.

We’ve done something completely different. Icon’s fees are based on a low, flat monthly fee of $4.00.

The comparison chart below shows what you’ll pay in annual fees based on how much money you have in your account. The amounts below don’t include fund management expenses. (We’ll get to that in a minute.)

 

$50,000 $250,000 $500,000

Icon

$4.00 flat monthly

 

 $48 $48 $48

401(k)

1.13%

(Small employer average*)

 $565 $2,825 $5,650

 

Now let’s compare fees once you add in fund management expenses. This is commonly referred to as an “all-in” cost.

The chart below shows what you can expect to pay annually on a savings balance of $100,000.

 

 Average Fund Expense Plan Administration Fees Annual Fees on $100,000

Icon

 0.08% $4.00 per month $128
Typical Robo-Advisor
 0.12% 0.40% $520
Manually managed portfolios

(Traditional advisors**)

 1.13% 0.99% $2,120
State-run IRA
 0.13% 0.87% $1,000
401(k)

(Small employer)

 0.79% 1.41% $2,200

 

Employee Fiduciary Average 401(k) plans of less than $2 million pay all in 2.22%; of that, we assume the average fund fee of 79 basis points and eliminate that from the total.
2016 Price Metrix Study of Retail Wealth Management: https://www.pricemetrix.com/cms/wp-content/uploads/State-of-Retail-Wealth-2016.pdf?t=1527206648**
https://www.businesswire.com/news/home/20180129005124/en/Three-Quarters-Americans-Dark-401-Fees
https://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article=5696&context=ylj

The Savers Tax Credit – Are you taking advantage of it?

Posted on March 30, 2018 by -

Eligibility

f you qualify for the Saver’s Tax Credit, it can reduce your tax bill and yet, few know about it. 

To be eligible to claim the Saver’s Tax Credit, you must be:

  • 18 years or older
  • Not a full-time student
  • Not a dependent on someone else’s taxes

The amount of the credit you can receive depends on your adjusted gross income (AGI). The credit can be 50%, 20%, or 10% of your retirement plan or IRA, up to $2,000 if filing single or $4,000 if married and filing jointly.

For 2022, the adjusted gross income (AGI) eligibility requirements for the Saver’s Tax Credit are:

Percent of your retirement savings contribution that qualifies for the Savers Credit Married filing jointly AGI Head of Household AGI Single filing AGI

50%

 $39,000 $29,250 $19,500

20%

 $39,001 – $42,500 $29,250 – $31,875 $19,501 – $21,250

10%

 $42,501 – $65,000 $31,876 – $48,750 $21,251 – $32,500

 

How does the tax credit work?

The Saver’s Tax Credit is a credit for contributions made to your Traditional IRA (or other qualified retirement plan or Roth IRA). Rollovers are not eligible for the Saver’s Tax Credit. Lastly, distributions from your retirement plan should also be deducted from the total contributions when calculating your credit. For more information, please visit https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit.

Claiming the credit

To claim the credit, use Form 8880

Reverse mortgages, how do they work?

Posted on March 29, 2018 by -

Reverse mortgages allow older people to access the equity they have built up in their homes. Repayment of the equity is deferred until the person sells the home or passes away.

How a reverse mortgage works

A reverse mortgage is a form of loan that allows you to turn some of your home’s equity (the value of your home minus the amount you still owe on your mortgage) into cash.  While a reverse mortgage can be a good source of cheap credit, it is important to remember that at the end of the day, it’s a loan like any other. That means you’ll pay interest on the loan and it does, eventually need to be repaid. 

The interest rate can be either fixed (stays the same over time) or variable (it’s subject to change at the lender’s discretion). Borrowers often view reverse mortgages as preferable to other forms of credit as their interest rates tend to be on the low side, although this isn’t always the case.

Unlike a home equity line of credit, a reverse mortgage does not need to be repaid until the borrower moves, is no longer able to meet the requirements of their mortgage, or passes away. A reverse mortgage can be paid out to you in a lump sum, in regular installments, as a line of credit (on an as needed basis), or some combination thereof.

The 3 Types of reverse mortgages

Single-purpose reverse mortgages are offered by local governments and are intended for low-income homeowners.  They must be used for a specific purpose outlined by the lender (i.e. necessary home repairs). 

Federally-insured reverse mortgages, or Home Equity Conversion Mortgages (HECMs), are provided by the federal government. These are the most common type of reverse mortgage, and have no income requirements or strings attached to their use (you can use a HECM for anything you want, like a new car or a child’s wedding). 

Proprietary reverse mortgages are offered by private lenders, and offer higher levels of credit than the other types of equity loans discussed, but also generally carry higher interest rates. These are not recommended for low-income borrowers or those with a modestly valued home, as they have a history of predatory practices towards financially vulnerable clients.

As with any loan, it’s important to consider whether an increase in debt is absolutely necessary. Reverse mortgages may be preferable to more expensive forms of credit, but you should evaluate all of your options before signing up.

The downsides of having a reverse mortgage

Inability to refinance and murky terms. Reverse mortgage documents can be confusing to read so before entering into a loan agreement, make sure you fully understand the terms of the said agreement. Unfavorable terms can include: 

  • Inability to renegotiate terms or refinance, which means borrowers could be stuck paying a high interest rate (which makes the loan hard to pay off). 
  • An adjustable rate that increases quickly that often catches borrowers unaware.

High interest rates and upfront costs. Interest rates on reverse mortgages can be 1.5% higher than regular home loans, and final costs could include lender fees, mortgage insurance premiums, finance charges and closing costs, all of which eat into the total amount available to you.

A strain on heirs. If you plan to leave your property to your heirs, they will have the option of paying the loan in full or 95% of the balance. If they can’t settle this debt with their own funds, the home must be sold in order to repay the lender. Also if you decide to sell the home you will have to repay the balance as soon as your house is sold.

Loss of equity in your home. Over time, the high accrued interest on your reverse mortgages may drain any remaining equity in your home. Moreover, some homeowners have found that lenders fail to keep accurate records, and there were obstacles when attempting to prevent foreclosure—such as slow response times (critical during foreclosure), receiving erroneous information or instructions, and general unresponsiveness. Before entering into an agreement, it would be wise to seek counsel of a trusted third party reverse mortgage professional or financial advisor.

 

Disability insurance, a great safety net

Posted on March 29, 2018 by -

Your ability to make a living is one of your most important assets. What happens if you’re injured and have to stop working for a period of time? Having disability insurance is one of the best ways to help make sure you have financial security.

How disability insurance works

If you suffer from an unexpected injury or illness that prevents you from working for an extended period of time, disability insurance can provide a critical source of income until you recover.

Traditionally, employers offered disability insurance to their employees automatically or as a voluntary benefit. But the employment landscape is changing and many people do not have an employer. What hasn’t changed is the need to have a disability policy in case you can’t work for a period of time, so you don’t have to dip into your savings.

What you need to know

Disability insurance works like any other insurance policy in that you pay regular premiums to guarantee that, when you need it most, you have the financial support you need to cover your expenses.

Premiums are generally equivalent to 1-3% of your annual income, and can pay out up to 60-80% of your income for the period in which you cannot work. The amount of time disability insurance will continue to pay out depends on the policy; most cover at least two years of disability, but more expensive policies can pay out for decades.

 

 

 

Why it’s a good idea to have a will

Posted on March 29, 2018 by -

Having a will is one of the most important financial and legal steps you can do for yourself and your loved ones. Not only will it spell out exactly how you’d like things to be handled once you pass on, it will make the process of your passing easier on your loved ones.

Getting Started

The steps to create a will are simple and include choosing an executor, appointing a guardian if you have dependents, and identifying your assets and property.

Choosing an executor and guardian

This is the person you designate to make sure your wishes are known concerning your property. It will also include naming a guardian for your dependents or your children.

Identifying your assets & property

Generally, most people leave the bulk of their assets and property to their spouses and children. If this is the case, it isn’t necessary to create a detailed list of all of your possessions. Of course, if you have special items you want to go to specific people, be sure and list them out.

Updating your will

Many people will put off drafting a will because they feel their financial situation may change before their passing. However, you can update your will as your circumstances change, so it’s really never too early to reach out to an estate attorney that can assist you with drafting one.

What if you pass without a will

If it’s unclear what you intended to do with your assets and property, the government may hold onto them for an extended period of time, which can result in litigation and stressful bureaucracy. By drafting a concise and comprehensive will in consultation with an estate attorney, you can dramatically ease this process.