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| Tools to Make Your Money Grow |
1. Protect Your Portfolio Like Buffett
Build a moat
In the constantly changing world of business, the key to investing success isn’t identifying companies that are growing the absolute fastest. Rather, it’s “determining the competitive advantage of any given company and, above all, the durability of that advantage,” Warren Buffett famously wrote.
He coined the term “wide moat” to describe firms with products, services, or business models that can stand the test of time.
You can own attractive wide-moat companies through Buffett’s Berkshire Hathaway, which Morningstar says is roughly 15% cheaper than the average stock in the S&P 500, based on its price/earnings ratio.
For a diversified approach, buy Market Vectors Wide Moat ETF It tracks the Morningstar Wide Moat Focus Index, which over the past 10 years has beaten the S&P 500 by five percentage points annually.
Or pick some wide-moat shares. Among MOAT’s holdings are Buffett-like stocks that dominate global markets, such as IBM, Coca-Cola, and General Electric.
2. Get Better Advice
Invest in a team, not a star
Even if you’re smart or lucky enough to find that rare stock picker who can consistently beat the market over time, there’s a good chance he will be gone before the long run comes around. The average number of years that an active manager stays with a stock fund is just 5.7.
One simple solution: Stick with stellar funds run by disciplined committees, not a single manager.
The nine-member group at Dodge & Cox Stock and the four-person team at Tweedy Browne Global Value have whipped the broad markets over the past three, five, 10, and 15 years.
Put your adviser under a “BrightScope”
When selecting planners, you want to know more than just their fees and disciplinary record. You also want to know their areas of expertise, typical customer, average account balance, and pay structure.
Screen advisers in your area using all of these variables at Brightscope.com’s financial adviser directory.
Pay next to nothing for basic help
Asset-allocation advice has become a cheap commodity, so don’t overpay.
New Internet-based advisers such as Wealthfront and Betterment charge annual fees of 0.15% to 0.35% in general.
Vanguard’s new Personal Advisor Services will offer portfolio management and a financial plan for 0.30%.
3. Make Smarter Choices
Get more by doing less
By trying to outsmart the market, overly active investors usually dig themselves into a hole.
In the past 20 years, the average stock fund investor earned just 4.3% annually while the S&P 500 gained 8.2%. Instead, just create a long-term plan and stick to it.
Do something by “doing nothing”
Here’s a mental trick that can help you stay the course. When trying to make decisions — for instance, Which gym should I join? or Where should I open an IRA? — toss in an option called “do nothing.”
Research from Wharton professor Rom Schrift and Georgia State’s Jeffrey Parker suggests that this small addition to your set of choices will subtly remind you of your goal (be it exercising or saving for retirement) and help you stay disciplined.
Buck up before you buy
You’ve probably heard the old saw about investing with your head, not your heart. At the very least, don’t make any financial decisions with a forlorn heart.
When feeling lonely or socially isolated, you’re more apt to take bigger risks with your money, according to a new study in the Journal of Consumer Research.
So “delay important financial decisions following a breakup or a falling-out with friends, colleagues, or family,” the study’s authors say.
Be a precise negotiator
A new Columbia Business School study finds that asking for an exact dollar amount — such as a $102,500 salary or a $5,375 raise — vs. a rounded figure gives you the upper hand when bargaining.
Using a specific number signals you are informed and “you’ve done your homework,” says professor Malia Mason.
4. Follow the Trend
Here are two demographic developments likely to move the markets for decades:
America’s echo boom
As the ratio of a country’s middle-aged (35- to 49-year-olds) to young (20 to 34) rises, so do stocks, says Ned Davis economist Alejandra Grindal.
Why? As folks age, they start to save more for retirement, which is good for the markets. The U.S. M/Y ratio surged in the ’80s, sank in the 2000s, but is expected to turn around next year, thanks to the aging of the millennials.
SPDR S&P Capital Markets ETF, with exposure to asset managers such as T. Rowe Price, should benefit.
China’s baby boom
Beijing is easing its one-child policy, starting off by allowing parents who are only children themselves to have a second kid.
“Think about what that means for demand for infant formula, food, education, and housing,” says David Winters, manager of the Wintergreen Fund.
A solid play on China’s rising consumer power: Matthews China Fund.
5. Start a Business
Steal a page from the wealthy
The Spectrem Group found business owners account for 6% of seven-figure households — triple that of doctors and lawyers.
Don’t expect to get rich quick; the payoff comes when you sell. The median price for a web-design firm last year was $687,500, according to BizBuySell. Construction firms fetched $2.1 million.
Be impatient for profits
Business owners all too often focus on future growth, not on immediate profits. Don’t make this mistake.
Long-term expansion is enticing, but grow too fast and your capital requirements and chances of failing increase, say Clayton Christensen and Michael Raynor, authors of The Innovator’s Solution.
6. Rethink Your Long-Term Investments
Grab the early-bird advantage
Investors have from Jan. 1 through the April tax-filing deadline the following year to fund an IRA. Yet the bulk of this money gets contributed in the last several weeks, forgoing more than a year’s worth of tax-free compounding. Here’s what you could gain by saving early:
Inflation-adjusted IRA balance in 30 years:
Early bird: $158,967
Procrastinator:$143,467
Note: Based in today’s dollars. Early-bird contributes Jan. 1 each year; procrastinators contribute April 1 the following year. Assumes $5,500 annual contributions gaining 4% after inflation. Source: Vanguard
Learn the ABCs of 529s
The trifecta of benefits for saving for college using a 529 account:
1. Your money grows tax-free.
2. Withdrawals for qualified educational expenses are tax-free.
3. And many states offer upfront deductions or credits if you choose your in-state plan.
After 18 years, $5,000 in annual savings will grow to $178,000 in a 529 savings plan while it will grow to $151,000 in a taxable account. (That’s assuming you’re in the 25% tax bracket and the accounts earn 6% a year).
7. Build a Better Portfolio
Say yes to rules of thumb
Planners warn against using mental shortcuts, since there’s nothing cookie cutter about your finances. Research from MIT begs to differ.
In one study, some entrepreneurs were given simple heuristics (e.g., keep your business accounts separate from personal ones) while others were schooled in accounting arcana. Those given rules of thumb were more successful and more likely to practice good accounting.
Rule of thumb: Your stock stake should be 110 minus your age
Pay zero taxes
0% — That’s the capital gains rate for selling a long-term investment if your ordinary income is below $73,800 for couples or $36,900 for singles.
As part of the fiscal-cliff compromise, Congress permanently extended the 0% long-term capital gains rate for those in lower income-tax brackets. Yet “many people aren’t aware how high the income threshold is for the zero rate,” says Tim Steffen, director of financial planning for Baird’s Private Wealth Management.
Build in safeguards, Part 1
The last thing that you think of when stocks are rocking is rolling back your exposure to the winners. But if the past two bear markets taught you anything, it’s to rebalance your portfolio and book profits along the way.
Start with areas that have far outpaced the S&P 500 since the bull began in 2009 — retailing stocks (up 313%) and real estate investment trusts (up 302%). Both are trading at valuations above their historical averages.
Build in safeguards, Part 2
Want an investment that will keep you safe in times of trouble? Seek out funds that over the past decade have lost less than the broad market in months when stocks have tumbled, while still outperforming over the past 10 years.
According to Morningstar, this list includes Mairs & Power Growth andVanguard Dividend Growth. Both have beaten more than 90% of their peers since 2004.
Think worst-case scenarios
After a five-year bull run, risk taking is back. This is precisely the time not to get too exuberant.
Gain some perspective by using this calculator: ativa.com/diversification-and-bear-markets. Check out how your current stock/bond allocation would have fared in each of the past eight recessions.
8. Make Credit Cards Work for You
Leverage cash-back offers
Don’t think of cash-back credit cards as unsecured borrowing but as a way to boost income in a low-rate world (provided you pay your balances off), says MyBankTracker.com’s Alex Matjanec.
Here’s what these no-annual-fee cards pay for routine spending:
For simplicity
The Capital One Quicksilver card is as uncomplicated as it gets. It rewards you 1.5% on all purchases, with no limit. It also comes with a $100 bonus if you spend $500 within three months of getting the card. Spend $2,000 a month and you’ll get $460 back by the end of the first year, for a 2% return.
For bigger reward
With Fidelity American Express you earn 2% on all purchases with no annual fee.
The downside: The money must go into a Fidelity-run account. If you choose a brokerage or cash management account, though, you can tap it in short order.
For even bigger payback
U.S. Bank Cash Plus offers higher rewards but makes you jump through some hoops.
You choose which categories of spending (ranging from cellphone bills to gym memberships) will pay you 5% back, and which common items (such as gas or groceries) will earn 2%. Everything else pays 1%.
9. Lock in Low Mortgage Rates
Three ways to remodel your mortgage
Based on recent comments by chair Janet Yellen, the Federal Reserve Board could raise short-term interest rates as soon as a year from now. Consider this a last call for grabbing cheap home financing:
30-year loans
This spring’s 4.4% rate on a 30-year fixed mortgage pales by comparison to 2012’s 3.3% low, but it’s still a good deal by historical standards.
Refinance a $300,000 loan you took out in 2008 at 6%, and you’ll save about $16,000 in total costs over the life of the loan.
15-year loans
Typically the difference between 15-year and 30-year rates is in the 0.5 to 0.75 percentage-point range. In the spring, 15-year fixed-rate mortgages were charging a full point less.
Your monthly nut would rise, but if you can swing it you’d save about $150,000 over the life of a $300,000 loan.
Home equity
With rates rising, fixed home-equity loans are a safer bet over variable-rate home-equity lines of credit. Credit unions offer lower rates (5.7%) than banks (6.1%).
Join the Pentagon Federal Credit Union with a one-time donation to a nonprofit; a 5- to 10-year PenFed HEL has a fixed rate of 3.99%.
Home sellers: Make your move now
If your strategy is to wait longer to sell, be careful. The pool of potential buyers may not be as robust as you think.
With home prices up 21% over the past two years, more buyers are feeling an affordability squeeze that will only get worse when loan rates rise.
And nearly two in five homebuyers say they’d “reconsider” purchasing a home if the 30-year rate climbs to 5% or higher.
Home buyers: Buy the smallest house in the best neighborhood you can afford.
10. Protect Against Inflation
Fight tomorrow’s war today
No one seems worried about inflation these days, notes financial planner Douglas Goldstein, but it’s bound to stage a comeback. Shield yourself now, before inflation hedges get too expensive:
Safeguard your cash with I bonds
These inflation-protected bonds, sold by the government at TreasuryDirect.gov, come with two interest rates. One is set when you buy the bond; the other is adjusted for inflation semi-annually.
New I bonds were recently paying a combined rate of 1.38%, vs. 0.12% for a one-year T-bill.
Defend your bonds with TIPS
Treasury Inflation-Protected Securities, or TIPS, have gotten a lot of bad press lately because of their so-called negative yields. The Vanguard Inflation-Protected Securities fund, for instance, yields — 0.2%.
That means if consumer prices grow 2% annually, you’ll earn around 1.8%, as the principal value and interest payments are adjusted to keep up with consumer prices. If inflation rises more than that, your payout will be even higher.
Take the fight abroad
Inflation may not be detectable in the U.S. just yet, but in India prices are already rising at an 8% annual clip, and in Russia it’s closer to 7%.
That’s eating away at the real returns of your foreign bonds. Buy SPDR DB International Government Inflation-Protected Bond ETF to fight this effect. The fund owns inflation-protected fixed income in both the developed and emerging markets.
Forget the usual hedges
Investors have traditionally turned to hard assets such as real estate and commodities to guard against inflation. Yet history shows these tools are barely as effective as cash.
11. Diversify
Go global
You’ve heard of the 4% rule, which limits how much you tap from your nest egg each year. A new study found this strategy works 66% of the time for retirees with a 50% stock/50% bond domestic portfolio.
Diversify globally and the success rate jumps to 78%.
When not to diversify, Part 1
There’s a 17% chance a portfolio of actively managed funds — one for U.S. stocks, one for foreign equities, and one for domestic bonds — beats an all-index approach. Boost that to three funds per asset class and your chances fall to 9%.
When not to diversify, Part 2
To save more, trim the number of banks you use.
A University of Kansas study found households with a single account saved more than those with multiple ones. You may use one account simply to hunt for top rates. If so, cap your total at two.
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