Ask Liz Weston

Get smart with your money

Investing

“Permanent” employment? No such animal

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Dear Liz: My spouse has tenure at a university. Given that one of us will always be employed, should we change the way we look at the amount of money we keep in an emergency fund or our risk tolerance for investments?

Answer: Even tenured professors can get fired or laid off. Tenure was designed to protect academic freedom, but professors can lose their jobs because of serious misconduct, incompetence or economic cutbacks, such as when a department is eliminated or a whole university is closed. About 2% of tenured faculty are dismissed in a typical year, according to the National Education Assn.’s Higher Education Department.

That’s more job security than in most occupations, of course. Your spouse also may have access to a defined benefit pension, which would give him or her a guaranteed income stream in retirement. Those factors mean you reasonably can take more risk with your other investments.

As for your emergency fund, you may be fine with savings equal to three months of expenses. But consider that if your spouse were to be dismissed, he or she probably would have a tough time finding an equivalent position. If the institution starts having financial difficulties or if there is any reason to suspect that he or she could be dismissed, a fatter fund could come in handy.

High, safe returns don’t exist

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Dear Liz: I’m getting about $500,000 from the sale of my business this year and next year will be getting an additional $1 million. What’s the best way to invest the money so I can make $150,000 to $200,000 a year? I am 55 years old and will have no other income than what I can earn with this money.

Answer: You probably know that “guaranteed” or “safe” returns are very low right now. If you’re getting much more than 1% annually, you’re having to take some risk of loss. The higher the potential returns, the greater the risk.

So even if you could find an investment that promised to return 10% to 13% a year, there are no guarantees such returns would last, plus you would be at risk of losing some or all of your investment. A down draft in the market or an extended vacancy in your real estate holdings could cause you to dig into your principal.

That’s why financial planners typically advise their clients not to expect to take more than 4% a year or so out of their portfolios if they expect those portfolios to last. If you try to take much more out or invest aggressively to earn more, you run a substantial risk of running out of money before you run out of breath.

Playing it safe could mean losing money

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Dear Liz: The certificate of deposit I owned in my Roth IRA recently matured. I’ve put the money into a Roth passbook account until I can figure out what to do with it. I’m a public school teacher and have a 457 deferred compensation plan to which I contribute monthly. I am 57 and will need to work until I am at least 65. What should I do with the money in my Roth?

Answer: As a public school teacher, you probably have a defined benefit pension that will give you a guaranteed monthly check for life once you retire. Depending on how long you’ve taught and where, this pension could cover a substantial portion of your living expenses.

The guaranteed nature of this pension means that you may be able to take more risk with your other investments. That would mean your Roth could be invested in stock mutual funds or exchange-traded funds that offer potential for growth. CDs and other “safe” investments can’t offer that — in fact, your money loses purchasing power since you’re not earning enough interest to even offset inflation.

Since you’re so close to retirement, you should invest a few hundred dollars in a session with a fee-only financial planner who can review your situation and offer personalized advice.

Are you paying too much for advice?

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Dear Liz: You always mention fee-only financial planners and I’m not sure about the true meaning. My husband and I have a financial planner who charges us $2,200 per year, but we got a summary of transaction fees in the amount of $6,200 for last year. Is this reasonable? We have $625,000 in IRAs and are adding $1,000 a month. In addition we have over $700,000 with current employers, adding the max allowed yearly. The planner gives advice on allocations for these employer funds as well. Are we paying too much for the financial planner? The IRAs seem to be doing well, but the market is doing well (today!).

Answer: It appears you’re paying both fees and commissions, so you’re not dealing with a fee-only planner. Fee-only planners are compensated only by the fees their clients pay, not by commissions or other “transaction fees” for the investments they buy. One big benefit of fee-only planners is that you don’t have to worry that commissions they get are affecting the investment advice they give you.

You’re paying about 1.3% on the portfolio you have invested with this advisor. That’s not shockingly high, but once you add in all the other costs associated with these investments, such as annual expense ratios and any account fees, your relationship with this advisor may be costing you 2% a year or more. That’s getting expensive, unless you’re getting comprehensive financial planning — help with insurance, taxes and estate planning, as well as investment advice — from someone qualified to provide such planning, such as a certified financial planner.

What you pay makes a big difference in what you accumulate. Let’s say your investments return an average of 8% a year over the next 20 years. If your costs average 1% a year, that would leave your IRAs worth about $3 million. If your costs average 2%, you could wind up with $2.5 million, or half a million dollars less.

Keeping your expenses low would mean you stop trying to beat the market with actively traded investments. Instead, you would opt for index funds and exchange-traded funds that seek to match market returns. These funds typically come with low expenses, often a small fraction of 1%. Using a fee-only planner can be another way to reduce what you pay for advice.

At the very least, consider bringing a copy of your portfolio to a fee-only planner for a second opinion. He or she can give you a better idea of whether what you’re paying is worth the results you’re getting.

High fees can break your nest egg

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Dear Liz: We have $130,000 invested in mutual funds, but the returns the last few years have been less than 4%. With the financial advisor taking 2% as a fee annually, we are not satisfied with the growth. A co-worker suggested buying blue-chip stocks with a strategy to hold and reinvest the dividends. If this is done in a self-directed plan to avoid the fees, we could be netting 4% plus. Is this a good plan or should we trust the advisor’s optimism that our returns will improve soon?

Answer: You don’t mention your age, your investment mix or your goals for this money. But if your portfolio isn’t doing significantly better this year — after all, the Standard & Poor’s 500 stock market benchmark is up about 30% over the last 12 months — you have cause for concern.

Even if your returns were better, a 2% fee is pretty high. Small investors need to keep an eagle eye on costs, since expenses can have a huge effect on your nest egg. Paying even 1% too much could shave more than $100,000 off your returns over the next 20 years.

That doesn’t mean, however, that an all-stock portfolio is a better choice. Individual stocks typically are much riskier than a diversified portfolio of mutual funds or exchange-traded funds (ETFs).

What might make more sense is consulting a fee-only financial planner who can design a low-cost portfolio for you. You can get referrals to planners who charge by the hour at http://www.garrettplanningnetwork.com.

Now available: My new book!

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Do you have questions about money? Here’s a secret: we all do, and sometimes finding the right answers can be tough. My new book, “There Are No Dumb Questions About Money,” can make it easier for you to figure out your financial world.

I’ve taken your toughest questions about money and answered them in a clear, easy-to-read format. This book can help you manage your spending, improve your credit and find the best way to pay off debt. It can help you make the right choices when you’re investing, paying for your children’s education and prioritizing your financial goals. I’ve also tackled the difficult, emotional side of money: how to get on the same page with your partner, cope with spendthrift children (or parents!) and talk about end-of-life issues that can be so difficult to discuss. (And if you think your family is dysfunctional about money, read Chapter 5…you’ll either find answers to your problems, or be grateful that your situation isn’t as bad as some of the ones described there!)

Interested? You can buy this ebook on iTunes or on Amazon.