1. Save More
Utilize the best retirement plan you’ve never heard of
You know that tax-free growth is a surefire way to boost wealth. Yet two-thirds of Americans in charge of making health-benefit decisions for their families don’t understand how health savings accounts can help them.
HSAs let you sock away money for medical tabs, but their real appeal is as long-term savings plans for retirement, when couples may need to set aside as much as $220,000 for health expenses, according to Fidelity.
Contributions (up to $6,550 for couples this year and $3,300 for singles) are pre-tax. Money grows tax-sheltered, and withdrawals for medical expenses are tax-free. “From a tax perspective it’s the best savings vehicle out there,” says Paul Fronstin of the Employee Benefit Research Institute.
You do need a high-deductible health plan (at least $2,500 for families and $1,250 for singles) to be eligible, but with the average deductible on a typical employer-sponsored plan at $1,850 for families, more Americans qualify. Invest funds set aside for the long term. HSAadministrators.info offers 22 low-cost Vanguard funds, while you get access to a TD Ameritrade brokerage via HSAbank.com.
Dust off the ol’ checkbook
Automating your payments sure makes life easier. A study in the Journal of Consumer Research, though, found that nothing promotes saving more than paying for things the old-fashioned way: non-electronically.
2. Bring Joy Back To Investing
Target-date funds and indexing have made investing easier, cheaper, and a bore. Let loose by taking a flier on these stocks with some play money:
LinkedInFacebook is the reigning social media stock, but Linkedln has a more reliable user base. And with details about members’ job histories, education, and skills, there’s more for advertisers to mine. Linkedln is “one of the few social Internet companies to truly hold a defensible position,” says Morningstar’s Rick Summer.
Skyworks As phones get smarter, this supplier of radio-frequency components will benefit, says Brian Lazorishak, portfolio manager at Chase Investment Council. Plus this will make you smile: The stock is up 33% annually for five years yet trades at a P/E of just 13.
Walt Disney For generations, this stock has been used to teach kids the love of investing. Time for the grown-ups to catch some pixie dust, says Lazorishak. In addition to its Mickey Mouse fare, the Magic Kingdom owns the highly profitable ESPN and the Star Wars franchise, set to launch three more films. Earnings are growing 13% annually — five points faster than the S&P 500.
3. Make Your Home An Asset
Go for McSavings, not McMansions
The old mindset in the heady days of the housing boom was to see how much house you could afford — and test that limit.
Here’s a new approach: Squeeze out as much savings as possible by purchasing a modest property at the lower end of your range. This one decision can save you six figures over 30 years.
You’d save $162,000 by buying a $300,000 house instead of a $375,000 home, if you put $75,000 down and take out a 30-year 4.4% mortgage.
Grab a second paycheck
More than one in four people who successfully retire early earn rental income. No surprise.
This source of wealth helps delay tapping your accounts early, and it’s inflation adjusted. The average monthly rent in the U.S. is $1,089, vs. the $900 mortgage (plus property tax) costs on a median single-family home, assuming 25% down.
Realty Trac says some of the best deals are in Chicago, Philadelphia, and Miami.
4. Invest Against The Grain
Bet on the tortoise, Part 1
Fast economies don’t deliver the biggest gains, says London Business School’s Elroy Dimson. Actually, equities in the slowest-growing nations have done the best since 1900, partly because these shares tend to be cheap.
Europe, the biggest tortoise for the next two years, typically trades at a premium to the S&P 500; today its P/E is 10% lower. For a value-minded approach, go with T. Rowe Price European Stock.
Bet on the tortoise, Part 2
Related research by Dimson shows that slow can be better in the emerging markets as well. From 1976 to 2013, equities in the most sluggish countries in the developing world beat stocks based in rapidly growing economies, again partly owing to being undervalued.
With a big stake in mature places like Mexico and South Africa, American Century Emerging Markets Value sports an average P/E of around 8, vs. 10 for the developing world.
Tilt small for big benefits
By boosting your stake in undervalued small-company shares — which have historically outperformed — you can take less risk elsewhere.
Portfolio no. 1: 70/30 strategy
Blue chip stocks: 70%
10-year annual total return: 6.5%
Worst 3-month loss: -21.5%
Portfolio no. 2: 60/40 strategy
Blue chips: 40%
Small-company stocks: 20%
10-year annual total return: 6.8%
Worst 3-month loss: – 19.4%
Notes: Vanguard 500 was used for blue chips. Vanguard Small Value ETF was used for small-caps, and Vanguard Total Bond Market Index was used for bonds. Source: Morningstar
Make sure you have this hedge
One reason to own foreign stocks is that currency fluctuations can boost returns and add to diversification. But with international bonds, the ups and downs of the dollar add risk you don’t want from your fixed-income stake.
So look for a foreign bond fund that uses hedging contracts to cancel currency moves.Vanguard Total International Bond is one that does.
Forget “buy on the dips”
It makes intuitive sense to move against the crowd. Just because equities are cheaper than they were last week, though, doesn’t mean they are a bargain. Some stocks deserve to see their prices fall. If you do want to make an opportunistic buy, however, do it when prices are cheap relative to a measure of value such as earnings
5. Use Funds To Tap High Muni Yields
Tax-exempt municipal bonds now offer a yield of more than 2% for intermediate-maturity issues, vs. an after-tax equivalent of about 1.5% for regular bonds. (That’s if you’re in the 28% bracket.)
Why use a fund rather than individual bonds? First, you get instant diversification. Second, a fund with low fees can be more cost-effective.
When you buy individual munis, you may pay a markup of 1.6% to 1.8%, according to J.R. Rieger of S&P Dow Jones Indices. He says funds pay a far lower cost.
Three excellent choices:
For your short-term moneyVanguard Limited Term costs 0.2% per year and should lose less than long-term funds if rates spike.
A core holdingVanguard Intermediate Term Tax Exempt takes moderate interest rate risk and holds high-quality bonds. It also charges 0.2%.
An ETF optioniShares National AMT-Free Muni Bond is the largest exchange-traded tax-exempt fund. Annual expenses are 0.25%.
6. Cut The Cost of College
Cut your college student’s cost of living
You can shave a lot off room-and-board expenses. Co-ops, offered at dozens of colleges, keep rent low by having students share cooking and cleaning. You’d save $9,000 annually by choosing a co-op instead of a dorm at UCLA.
Another option: Dorm resident advisers often get free rooms.
Pick a less picky school to get more aid
Having your child apply to several safety schools for college isn’t just about making sure she gets in. It may also help her snag an attractive aid offer. According to the College Board, at highly selective private colleges, a little more than a third of students get merit aid. At moderately selective schools, 57% do.
Help the grandkids with college, without hurting yourself
Want to help your kids pay for their sprouts’ education, but worry a bit about giving up money you could need down the road? Save in a 529 account in your name with the child as the beneficiary. You can withdraw the cash for your own non-educational expenses if you must.” It’s the only vehicle out there that removes money from an estate but allows you to take it back at any time,” says Joseph Hurley of Savingforcollege.com.
You’ll owe taxes and a 10% penalty on earnings if you use the money yourself, but that’s a small price to pay for flexibility.
Avoid parental bailouts
Your kids’ college debt shouldn’t exceed a year of post-grad pay.
7. Boost Your Income
Know the real score
Need motivation to save more? Don’t look at the size of your nest egg. Figure out how much income that will create at retirement.
Putnam says 35% of 401(k) investors who use its income calculator change their savings habits, and three-quarters of those people boost their savings an average of 25%. For a free option, check out T. Rowe Price’s income calculator.
Cast a wider net for income
When even high-yield junk bond funds are paying you less than 5%, you know it’s time to get creative. Peer-to-peer lending sites, which connect you with would-be borrowers who are willing to pay you higher-than-average interest rates to loan them money, may seem dicey.
Stick with the Lending Club’s highest-quality loans — since 2008, the default rate has been a minuscule 0.004%. These investments have returned a net 5.3% annualized.
Hold cash for the long(ish) run
With interest rates low and likely to rise, some of the money you currently hold in bonds may be better off safe in cash. A five-year CD from Barclays now pays 2.25% a year.
There’s a penalty for cashing out early, but if you hold for just a year you earn 1.13%, says DepositAccounts.com.
Diversify for income
It’s tough to find income these days. Rob Williams at the Schwab Center for Financial Research proposes the following mix for moderately conservative investors who want a better payout.
Portfolio for income:
32% U.S. high-quality bonds, such as Vanguard Total Bond Fund
18% International and high-yield bonds, such as Vanguard Total International Bond and Fidelity High Income.
25% Large U.S. companies with dividends, such as SPDR S&P Dividend ETF
10% International stocks with dividends, such as Powershares International Dividend Achievers ETF
5% Small companies, such as Wisdomtree Small Cap Dividend ETF
Note: Fund picks by MONEY
8. Save Smarter for Retirement
Master asset location
Maxed out tax-advantaged savings and now have taxable accounts, too? Holding assets in the right places can add up to 0.75% in after-tax return per year, says Vanguard. Favor 401(k)s and IRAs for investments which generate a lot of highly taxed income or distributions.
Get back foreign taxes
It often makes sense to hold your foreign stocks in a taxable account if you have one, says financial adviser John Burke.
“You can apply for a federal tax deduction or credit on tax withheld by foreign governments on investment income,” he says. This only applies, however, to taxable accounts.
Check that target date
These funds, a popular choice in 401(k) plans, automatically adjust your mix of stocks and bonds as you age.
For much of your career it’s fine to default to a target fund. But as you approach retirement, take a closer look at your plan. A target-date fund may have 56% of assets in stocks for investors at age 65. That can help power growth over your retirement, but it also means that if there were a repeat of the 2008 crash, you could lose 20% or more of your savings in a year.
If that’s not a risk you can handle, plot your own course. One easy solution: Pick another target fund in your plan meant for someone older; it will take less risk.
“Sneak” into an IRA
Earn $191,000 or more as a couple, and the direct route into a Roth IRA is closed. Fortunately, there’s a legit workaround: Make a contribution to a non-deductible IRA, then immediately covert to a Roth. (The usual contribution limits apply: up to $5,500 per person or $6,500 at and after 50.)
But be careful of this catch. If you have other savings in a traditional IRA account, for which you once took deductions, you’ll now owe taxes on part of the money you convert. (The amount depends on how much is in the traditional IRA.)
So don’t make this move if you have to raid money from the IRA to pay the taxes, since you’ll cut into your savings’ compounding power, says Ed Slott, founder of IRAHelp.com.
Forget “buy on the dips”
It makes intuitive sense to move against the crowd. Just because equities are cheaper than they were last week, though, doesn’t mean they are a bargain. Some stocks deserve to see their prices fall.
If you do want to make an opportunistic buy, however, do it when prices are cheap relative to a measure of value such as earnings.
9. Have a Retirement Spending Strategy
Building up assets over your career is just part of the job. Once you retire, you need a new kind of plan to ensure that you’ll have wealth to tap for the rest of your life. That’s tricky, since you can’t be sure how long you’ll be around.
Three ways to make the money last:
Put your portfolio in buckets
In other words, segment your nest egg based on when you need the money, says Christine Benz, director of personal finance at Morningstar.
In bucket one goes money for expenses in the first two years — that’s cash, CDs, and money markets. Bucket two is for the rest of the next 10 years and holds TIPS and a core bond fund. Bucket three holds equities and higher-yielding bond funds for growth. Each year rebalance so that you still have two years of cash in bucket one and plenty of bonds in bucket two.
Buy annuities, slowly
With an immediate annuity, you give an insurer a lump sum and get a fixed monthly payout for life. The problem: Interest rates determine payouts, and right now rates are very low. One way to handle that is to buy annuities over the course of a few years so that you capture higher payouts if interest rates go up, as expected.
Bet on extra longevity
If you feel confident you can stretch your investments to last you until 80 but want to be guaranteed a lifelong income after that, consider a deferred-income annuity.
You buy now, but can set the payments to kick in 25 years down the road. As long as you live long enough to collect the benefit, the payout can be attractive.
A 55-year-old man who invests a $50,000 lump sum today would lock in about $23,000 a year in income starting at age 80.
Preserve IRA wealth
If you have enough in your IRA to leave to the next generation, but worry Junior will cash it out, set up a trusteed IRA. Beneficiaries must take required minimum distributions, but otherwise the trustee directs money according to your wishes, says Plano, Texas, planner Ken Moraif. Get a lawyer to help.
Stretch those legs — and stretch your dollars
Need a little extra motivation to keep up a physically active lifestyle? The healthier you are, the less of your nest egg you’ll need to spend in each year of retirement, according to Fidelity research.
Spending as a % of pre-retirement income:
If you are in excellent health: 77%
If you have several chronic conditions: 96%