DH invests 12% of his salary into the company employee stock purchase plan (ESPP). Every six months, the plan purchases shares. My understanding is that they look at the market prices on the first and last day of the plan period, and then take an additional 15% off the lesser price.

The latest period closed on 7/31, and was one of the best periods we've seen. The ESPP purchase price was $29.99, and the current market price is $46.97. This period, DH put in $7827, and if he sells now will realize a gain of $4432. 56%return for a six month investment!

Of course this isn't typical, but in general we can count on a 15% return, although there is always the risk with stocks that a very sharp downturn could turn it into a loss in the few days between purchase and when the shares reach our account.

The one wrinkle is taxes. We could hold it for two years, and then only have to pay long-term capital gains tax. Since it's a high-tech stock, this is kind of a risky move. If we sell it within a year, we'll pay income tax on the 15% discount, and short-term captial gains on the rest.

It does make it a little more complicated when we go down to one income, since I need that $1300/mo to make our budget work. If we sell immediately, I'll set aside $7800 and treat it for budget purposes like $1300/mo income. If we don't sell immediately, I'll "borrow" the money from the emergency fund and repay it when we sell.

DH and I need to talk about what do do with the $4400 gain. After setting aside some for taxes, the rest could either go into his stock-trading account, or into our vacation fund. He wants to take a big trip (possibly a Mediterranean cruise) when we turn 40 next year, but I don't currently have funds allocated toward that, nor room in the budget to save the amount we'd need.

Other good news -- with the stock market recovery, our net worth just topped 1 million again.

My brother was here for a visit this week, and we had an interesting conversation about mutual funds. My dad used to be a stock broker, and now works for a mutual fund company that sells actively managed funds that carry a load. Of course he believes that you're getting the value of research that you're paying for with the load and management fees. My brother got both an engineering degree and an MBA. He now works in marketing, but because of his degree has more background in finance than I do.

Anyway, when my dad left his former company, there was a big going-away dinner that my brother attended. He said that it hit him that all these guys at the dinner, who were full-service brokers, are really just salesmen. They don't have a finance degree or tons of training in portfolio analysis. The advice they give is basically fed to them by the parent company.

My brother has had more interest than me in actively investing. He got burned on penny stocks early on, then a couple of years ago he looked at his individual stock-picking efforts and decided he was better off in mutual funds. After the recent market crash, my brother said he took a look at the actively managed funds he owned that were from the company my dad works for. In his opinion, they fared just as badly as the rest of the market, and did not see a large upside during the boom years. He has since unloaded most of his actively managed fund and moved the money to low-cost index funds.

While I question his judgement in getting out at the bottom, and I have no idea how big his portfolio is or which funds he used to own, it was interesting to know he had changed his strategy to one I hear many people here using.

My dad, a former stockbroker who now works for a mutual fund company, called me yesterday afternoon. He said the DOW was down to 7500 and he wanted to add $1,000 to my son's 529 account. He asked me to go ahead and make the purchase and he would send me a check. Thanks, Dad!

It's funny that he's always preached dollar cost averaging, but now he calls me up when the DOW has a big dip and tells me to "buy low". I can't figure him out.

I guess procrastination is once again in my favor. When the stock market had its big fall in October, to 8500, I had $14k sitting in cash within my various IRAs. I invested $10k, and thought I'd wait a month or so with the remainder to see if we got another dip. Then I promptly forgot about it. So now I've got $4k still sitting there and I think I'll invest. Who knows, with the bad economy the DOW could go even lower but I'm not going to wait.

It pains me to realize I still don't have a plan in place to know WHICH fund I want to buy. Guess I'll call my dad again and see which one he recommends.

If only we had our taxes done. I set aside 40% of my consulting income with evey paycheck for taxes. I ran through a quick online calculator and it looks like our effective federal tax rate is going to be about 20%, and we'll only owe a couple thousand this year. So I may have as much as $10k available to put in our IRAs. (We don't qualify for ROTH.) It would've been nice to invest it now, while the DOW is low, but I guess if the DOW goes lower it will be nice to have money to invest then.

I took advantage of Morningstar's open house to try out the portfolio tools and x-ray. It will take me just as long to manually enter it in instant-x ray (which is free) each time so I'm not going to pay $160/yr for the premium membership.

Here's our current allocation according to x-ray:
U.S. Stock: 34%
Foreign stock: 46%
Bonds: 9%
Cash: 10%
Other: 1%


Here's the target I came up with:
stock: 75%
bond: 10%
cash: 5%
real estate: 5%
commodity: 5%

So I'm not too far off. I've decided I'm only going to rebalance my portfolio if it strays more than 10% from my target, and not at all when the market is going crazy like right now. Instead of selling stock to invest in REIT and commodity, I'm going to direct new investments in that direction. I have $9k in cash in the investment accounts right now (which is only about 2% of the portfolio) -- so I'll start shopping around for a REIT. The rest of the cash is from mutual fund managers deciding to hold cash. I figure I'm paying for them to use their judgement on that, so I won't argue with them.

The style allocation for the stock matched very closely with the Wileshire 5000.
value blend growth
large-cap 26.5 27 23
mid-cap 5 4 9.5
small-cap 1.5 1.5 2

The international stock has a large-ish bet on Asia:
US & Canada: 45%
Europe: 26%
Japan: 3%
Latin America: 5%
Asia & Australia: 16%
Other: 5%

My average mutual fund expense ratio is 0.69%, which I was pleased to see.

When I read a good financial book, I like to take notes for my future reference and for the benefit of others here who might be inspired to go read it. You can see my past entries by clicking on the Booknotes catagory.

I actually read The Morningstar Guide to Mutual Funds several months ago, and just came across my notes -- so the details may be a little rusty. It was well-written, but I find I have a mental block when it comes to reading about investing (very odd considering I'm a bookworm who averages about a book a week.) It took me several libary renewals to get through this one.

This book is the first one I've read that really focuses on the process of how to choose a particular fund, as opposed to generalities of what mutual funds are, and for that I highly recommend it. It explains how to use the information available on Morningstar's website to choose funds.

Questions to ask yourself to check whether you thorougly understand a fund:
* What does the fund own (style, catagory sector)
* How has the fund performed? (3,5,10 year returns, calendar year return, average annualized return, after-tax return)
* How risky has the fund been? (standard deviation, top 10 concentration, Morningstar risk rating)
* Who runs the fund? (fund manager's history)
* What is the fund family like?
* What does the fund cost? (loads, expense ratio)

Know what a fund owns:
* Understand the style box -- this tells you if the fund invests in small, medium, or large companies, and also whether it buys stocks because they are "on sale" (value - a good price compared to history for that stock) or are expected to increase in price quickly (growth) or a combination (blend).
* Check the sector weightings. This tells you how much the fund is investing in different kinds of companies -- say banking, industrial, or high tech
* Check the number of holdings (more stocks = less risk)
* Check the turnover rate (lower is better). If the fund buys and sells a lot, trading fees will decrease the return.

Performance -- things to look at when comparing funds:
* Annualized return
* After-tax return
* Compare the fund's return to the right benchmark

* large cap: S&P 500
* small cap: Russell 5000
* foreign: MSCI EAFE
* taxable bond: Lehman Brothers Aggregate Bond

* Also compare the fund's return to the Morningstar index for corresponding style box
* Look at the long-term history -- the 3, 5, and 10 year returns
* Note how long the manager has been with the fund -- good historical results may have come from a previous manager
* Look at the calendary year returns -- this will tell you if one exceptionally good year is making the other long term results look better than is warranted.

Analyze the Fund's Risk:
* Add up the % invested in the top ten holdings -- how concentrated is the fund in these stocks?
* Style risk: Large-value is the least risky, small-growth has the most risk
* Past volatility: look at the worst calendar year. If it happened again, would you be willing to ride it out or would you feel compelled to sell?
* Standard deviation: this tells how much the fund has varied from the 3 year average. 68% of the time, your return will be within 1 standard deviation. Lower is better (means the fund is more consistent). Compare a fund's standard deviation to the standard deviation of the index.
* Morningstar's risk rating:

* low: least risky 10% of funds
* below-average: next 22.5%
* average: the middle 35% in terms of risk
* above-average: next 22.5%
* high: most risky 10% of funds

Evaluating the Fund Manager
* Look for 10 years experience as an analyst or portfolio manager, with at least 5 of these years as a portfolio manager
* Seek ones who spent their early years at a high-quality firm like Fidelity or American Funds
* Management changes -- consider selling if the management changes and the fund is from a small family has just a handful of fund, or if the fund is the only good one in that family, or if the catagory is small or emerging markets

Analyze Costs
* Growth, small-cap, and international funds will have higher expense ratios because they require the fund to do more research.
* Look for funds charging < 1.25%
* Compare the fund's expense ratio to the following averages:

* large-value: 1.41
* large-blend: 1.24
* large-growth: 1.5
* mid-value: 1.43
* mid-blend: 1.40
* mid-growth: 1.60
* small-value: 1.51
* small-blend: 1.53
* small-growth: 1.64
* Foreign (Europe, Japan, and World): 1.75
* Foreign (emerging markets): 2.19
* Sector funds: 1.72

Portfolio Mix
* Main asset classes are stock, bond, and cash. Some consider foreign, emerging markets, and REITs as separate classes.
* Diversity among the main classes is the most important.
* Diversity among the sub classes (style box, foreign) is useful but not as crucial.

Where to invest money for your short-term goals (plan to use the money in 1-5 years)
* Money-market
* Ultra-short bond funds (bond maturities < 6 months)

Where to invest money for your medium-term goals (plan to use the money in 5-10 years)
* 25% in short-term bond or cash
* 75% in stock funds -- either large-blend or balanced funds
* Shift the money into bonds as you get closer to the goal

Where to invest for long term goals
* I seem to be missing notes for this

Structuring your Portfolio
* Your foundation should be made of a core of funds, comprising 50-80% of your assets. Recommend large-cap domestic fund for the foundation
* Small cap should be < 20% of your portfolio
* Consider having some foreign funds in developed markets (ie Europe and Japan)
* Risk diminishes significantly by owning at least 3 funds
* Above 7-10 funds, risk doesn't diminish
* Watch out for overlap if you own multiple large-cap funds
* Four-corners strategy: invest in large-value, large-growth, small-value, and small-growth
* Check total exposure to each catagory sector -- no more than 30% in any one sector

Write down why you bought each investment.

Understanding the investment strategy of your fund:
Value Styles:

* relative-value: choose stocks that are cheap compared to benchmark such as historical price ratios, industry, or overall market. American Funds Washington Mutual is recommended for this strategy
* absolute-value: figure out what a company is worth, and buy when the stock price is less than that amount. Manager studies the company's assets, balance sheet, and growth patterns. Be prepared to wait out long dry spells.

Growth Styles:
[indent]* earnings driven or "momentum": focus on identifying accelerating earnings. This style has a price risk -- the price of a stock may plunge on bad news. These funds tend to have significant short-term drops.
* revenue-driven: buy stocks that have strong revenues
* GARP (growth at a reasonable price): strike a balance between strong earnings and good value. Fidelity Magellan is a recommended example

I think there may be one or two chapters at the end that I didn't cover...

I have mentioned before that my dad used to be a stockbroker with a full-service brokerage, and now works for a mutual fund company. You'd think I would've gotten a great education in investing from him, but I find I'm having to go out and read books to educate myself like everone else.

In the past when I've asked him to teach me about investing, I'd get a 5 minute lesson that involved comparing this year's year-to-date (or was it 1-year?)return to the 10 year average for that fund. Once he sent me a book by Jane Bryant Quinn that defined bonds and mutual funds but didn't explain how to pick a particular fund.

Recently I asked him about asset allocation and he said he doesn't believe in rebalancing -- it was just a way for authors to sell books and advisors to look like they're doing something.

Dad doesn't believe in index funds -- he once told me that their popularity had driven up the price too much. And of course he believes that you're getting the value of research by buying loaded mutual funds.

I once asked him at what point would I have saved enough for retirement and could enjoy the present a little more. "Save every penny you can," was his answer.

To be fair, Dad always did tell me which funds to pick in my 401k, and will periodically tell me that a particular fund at his company is "on sale" compared to its historical price. He explained the basic concept of a mutual fund and dollar cost averaging when I was in high school.

Despite all this, Dad did pass along some core bits of advice that have made a big difference in getting where I am today:
* live below your means
* save as much as you can
* start your 401k the day you are eligible
* max out your 401k
* long-term owners do better than long-term loaners (ie stocks outperform bonds and bank accounts in the long run)
* don't put all your eggs in one basket
* start investing in your 20's
* send $50 or $100 to a mutual fund every month(unfortunately I didn't keep following this one)
* mutual funds (at least the ones in his company) will on average go up 3 out of 4 years, and lose money 1 out of 4 years.
* don't buy the most expensive house on the block

From the short quizzes in the Perfect Portfolio book, I was rated to have a moderate risk tolerance (3 on a scale of 1-5), and a moderately aggressive risk profile (2 on a scale of 1-5). I think the risk tolerance quizzes actually tend to underestimate my true tolerance -- I didn't bat an eye when my portfolio dropped $200k in the recent downturn.

So I've decided that a growth allocation is my goal. Here's the starting point that the book recommends:
Goal: Growth
stock: 60%
bond: 20%
cash: 10%
real estate: 5%
commodity: 5%

Given my age, I think that's far too much in bonds and cash. It was a hard sell to convince me that bonds are necessary at all, but The Intelligent Asset Allocator made a really good case for holding 10% in bonds. One thing that I'm never sure about is whether to count our checking, savings, and emergency fund in the cash portion or not. I plan to exclude it just to make the calculations easier (so I can just put the funds in x-ray and ignore the other accounts.)

Here's what I think I'll aim for:
My target:
stock: 75%
bond: 10%
cash: 5%
real estate: 5%
commodity: 5%

I've been interested in adding a REIT at some point, and based on the book's advice I think I'll do it within my SEP-IRA.

The book had very little advice about how to allocate the stocks within the catagories (small, mid, large cap; value, growth, blend), so I still need to make some decisions in that area. I think it's possible we may be entering a decade with little growth, so I will lean toward mutual funds that generate dividends.

I'll come back and edit this post later with my actual current allocation once I run the numbers through x-ray.

When I read a good book on investing, I sometimes like to take notes and record them here on my blog -- both for my future reference and for others here who might be interested.

Today's book is The Standard & Poor's Guide to the Perfect Portfolio: 5 Steps to Allocate Your Assets and Ensure a Lifetime of Wealth by Michael Kaye. It focuses mainly on how to decide upon the right asset allocation for you. You need to understand the basics about stocks, mutual funds, and bonds before reading this book.

The three main asset classes are equities (ie stocks and mutual funds), bonds, and cash (ie bank account, money market, CD, etc.). Real estate and commodities can also be considered asset classes.
------------
Suggested Asset allocations -- adjust these to suit your own risk tolerance and other factors discussed in the book(age, marital status, investing experience, dependents, and affluence).

Goal: Capital Preservation
stock: 0%
bond: 25%
cash: 75%
real estate: 0%
commodity: 0%

Goal: Income
stock: 25%
bond: 45%
cash: 20%
real estate: 10%
commodity: 0%

Goal: Growth & Income:
stock: 45%
bond: 30%
cash: 20%
real estate: 5%
commodity: 0%

Goal: Growth
stock: 60%
bond: 20%
cash: 10%
real estate: 5%
commodity: 5%

Goal: Aggressive Growth
stock: 85%
bond: 0%
cash: 0%
real estate: 5%
commodity: 10%
------------
Universal Rules for your portfolio
* No more than 75% of your portfolio in any one asset class.
* At least 5% in cash instruments
* At least 5% in international equities
* Have exposure to at least three asset classes.
* No more than 10% in any one stock
* At least 25% in stocks
* At least 10% in bonds
* Consider rebalancing if an asset class moves at least 5% from your target, but do not rebalance more than once a year.
----------
For the best tax treatment here are the best places to hold different kinds of investments:
Taxable Account:
* Index mutual funds
* Index ETF
* Municipal bonds
* Individual stocks (held > 1 yr)
* Tax-managed mutual funds
* International funds
* Cash instruments

Tax deferred and tax free accounts:
* Actively managed mutual funds
* REITs
* TIPS
* High-yield junk bonds
* Stocks held < 1 yr
* Corporate bonds
-------------
Impact of the Economy
Historically, different strategies have worked best in the following economic conditions:

Low Interest Rates
* stocks & bonds perform better than real estate and commodities
* mory risky stocks and bonds are the best performers

High Interest Rates (nominal > 8%)
* conservative investments perform best
* equity: staples, pharmaceuticals
* bonds: short-term
* cash: money markets

Rising Interest Rates
* increase short-term bond & money market
* equity: staples, pharmaceuticals

Falling Interest Rates
* stocks & bonds
* equity: banking, home building
* long-term bonds
* CD's

High Inflation
* stocks, bonds, and cash all do poorly -- but of these stocks fare best
* real estate and commodies do well
* international equities
* TIPS
* money market best for cash

Low Inflation
* stocks, bonds, cash do better than real estate and commodity
* more aggresive stocks do well -- technology, consumer discretionary
* longer term bonds

Growing Economy
* more aggressive investments

Recession
* staples, pharmaceuticals, utilities
* lower maturity, high quality bonds
* real estate does poorly

-------------
Compare your investments against benchmarks:
* equity -- S&P 500
* small cap equity -- S&P 600 Small Cap Index
* bonds -- Lehman Aggregate
* cash -- Citigroup 3 month T-bill index
* commodities -- S&P-Goldman Sachs Commodities Index

--------------
Other notes:
In taxable accounts, don't rebalance by selling -- instead redirect new money to a different asset class.

small-cap mutual funds tend to generate larger tax bills than large-caps due to companies growing out of the small-cap classification and the stocks being sold.

REITs are one way to hold real estate. Two main kinds:
* equity REIT owns rental properties
* mortgage REIT owns mortgages

----------
I fall in the "Middle Career" phase of life. Recommendations:
* life insurance important
* fund retirement
* fund 529
* have will & guardian in place
* 6 months expenses for emergency fund
* tax-advantaged -- slightly more conservative than early career
* taxable accounts -- slightly more aggressive than early caeer
* focus on investments with low expenses, low taxes
------------

It's no surprise that all of our investment accounts have been hit hard by the recent stock market plunge. This morning I decided to bite the bullet and see how bad the fallout was. It turns out I'm no longer a millionaire -- net worth is down to $840k. All things considered, I can't complain -- it was just fun to call myself a millionaire while it lasted. I am confident the stock market will recover over the next few years and we will be in good shape for retirement 20 years from now. I guess my new goal can be to reach $1M net worth again by the age of 40.

Jim_Ohio had a very interesting post about whether high-income earners (above the ROTH limit) should direct money toward a taxable account or a non-deductible IRA. In the comments he asked me a series of questions, so I thought I'd blog a bit about our situation, and maybe if I'm lucky Jim will stop by and give me his take.

Currently DH makes about $130k. I have the choice to work or not -- currently I'm contracting 20 hr/wk and expect to gross about $60k. We'll probably have about $35k in deductions, plus $10k in exemptions. Last year we had $9k in dividends and $23k in capital gains.

Our tax situation this year will be very different from last year, since I only worked for 5 months and didn't start with as many hours. Last year, our AGI was $169k, my business income was $23k, our taxable income was $124k. I'm guessing our marginal tax bracket was 25%, but our effective tax rate was 10.5% federal and 9% state.

1) How much are you investing each year? In the taxable account?
$15,500 to DH's 401k
$13k to DH's ESPP
$4k to DH's traditional IRA
$4k to my traditional IRA
No new money to my taxable account.

The IRA contributions will likely come from selling existing taxable mutual funds rather than new income.

2) how many years to retirement? Is early retirement a desire?
We are almost 38 now, so theoretically 27 years. I'd like the option of retiring at 60, so 22 years.

3) is mortgage paid off? Is their any reason to NOT pay the mortgage off?
The mortgage is a 10-1 ARM that is fixed at 5.125% until 2012. I think it's more advantageous for us to have the mortgage deduction and invest in the stock market instead of paying it off. Also, there is a fair chance that we will want to move to a better school district in 3-5 years time.

4) What choices are available for health care (HSA?), child care (child care account available?) and other less used deductions.
DH has excellent medical coverage, completely employer-funded, so no HSA.
We're currently taking advantage of the FSA health deduction, although I've been burned with it in the past. The dependent care deduction is tricky -- currently the part-time nanny prefers to be on a cash basis. To use the deduction we'd have to set up tax withholding, etc.

Here's our current strategy:

I wait until TurboTax tells me whether we qualify to contribute to a ROTH or not. We qualified for a partial contribution the year that I was not working, or I could take a deduction on a spousal IRA.

When we don't qualify for ROTH, we contribute $4k each to non-deductible IRA.

Now that I have business income, I sell stock in my taxable account to make the maximum contribution to the SEP-IRA to reduce the taxable business income.

One wrinkle -- it's quite possible that we will be in a higher tax bracket in retirement than we are now. I've been playing with the retirement calculators at http://www.hughchou.org/calc/index.html#RET. Our current retirent accounts total $339k, and current taxable accounts total $357k. I asked for $200k income and assumed 10% return. If we save all that for retirement, and don't contribute another dime, the calculator says we're "set for life". If I just look at the retirement balance, and assume we add $24k to it each year, and assume a 10% return, we're still good for a $200k (current dollar) income.

So what do you think, Jim? Am I better off to leave that $8k each year in the taxable account, or move it over to the IRA?