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April 30, 2009

What's Happening with Muni Bonds?

Traditionally, municipal bonds have been relatively safe investments. Over the past couple of years, however, that market has been extremely volatile, due to several factors:

Credit ratings of bond insurers have been downgraded. Historically, the municipal bond market has experienced very few defaults, making their credit quality relatively high. However, a significant portion of municipal bond investors are individuals, who wanted added assurance that these investments were safe. Thus, in the late 1980s, insurance companies started issuing municipal bond insurance, which grew significantly in popularity. Recently, over 50% of all new municipal bonds obtained this insurance. The bond issuer purchases the insurance when the bonds are brought to market, with the insurance company committing to make timely payment of principal and interest in the event of the bond issuer's default. When the bonds are insured, the bond receives the same rating as the insurance company's rating.

Initially, insurance companies only provided insurance for municipal bonds, but then they started insuring taxable bonds as well. Some of that debt was tied to subprime mortgages, which caused problems for the insurance companies. Due to sizable losses from the subprime mortgage products, the ratings of several insurance companies were downgraded, causing the downgrading of ratings of underlying municipal bonds. While the insurance companies received downgrades to their ratings due to losses on taxable insured bonds, that had a direct impact on municipal bonds. Typically, most of the insured bonds are investment-grade quality, even without the benefit of the insurance. However, many municipal bonds are trading based on the underlying rating of the bond or even lower, with no consideration given for the insurance.

Auctions for auction-rate bonds started to fail. Auction-rate municipal bonds are long-term bonds with maturities of 10 to 30 years that have a floating interest rate. Every seven to 28 days, the bond underwriter holds an auction to reset the interest rate. The auction is a Dutch auction, which means that the interest rate is reset at the lowest rate that results in a sale of all the bonds. For issuers, they are basically issuing long-term bonds at short-term rates. Investors receive a highly liquid bond that can be sold in an upcoming auction, while earning interest rates slightly higher than money market rates. If there are not enough bids to complete the auction, the sellers are not able to sell their bonds, but they receive a predetermined penalty interest rate. Traditionally, if there were not enough buyers, the underwriter would step in and purchase the bonds. In January 2008, an auction failed because the underwriter would not step in. After that, auction failures became widespread, putting further pressure on municipal bonds.

Many institutional investors sold their muni bonds. Some institutional investors had to sell muni bonds because their ratings had dropped below allowable limits. Of more consequence, however, was the fact that billions of dollars of municipal bonds were sold by hedge funds to meet margin calls. Troubled banks, brokers, and insurance companies have also sold massive amounts of muni bonds to raise cash. The end result has been that there are more sellers than buyers, further depressing muni bond prices.

What Is the Current Situation?

Historically, municipal bonds have yielded less than Treasury securities, because their income is exempt from federal income taxes and possibly state and local income taxes. The ratio of yields between the two securities has varied over time, depending on prevailing interest rates and tax rates. For individual investors, the attractiveness of municipal bonds is highly dependent on their individual tax bracket. Municipal bonds with maturities of 10 years or more have typically yielded between 80% and 90% of Treasury bond yields.

Over the past several months, it has not been uncommon to see ratios of 150% to 300%, meaning that the interest rates on municipal bonds are substantially higher than Treasury securities, despite the income tax advantages.

Should You Invest in Municipal Bonds?

By historical measures, municipal bonds are very cheap compared to Treasury securities. On a tax-equivalent basis, assuming you are in the 25% tax bracket, a AAA-rated 10-year municipal bond is yielding 4.31% compared to 3.03% for a 10-year Treasury security. But does that mean that you should purchase them?

The municipal bond market has become very volatile over the past couple of years, and no one knows when or even if it will return to normal levels. However, if the current situation corrects itself and the ratio between Treasuries and munis goes back to more traditional levels, purchasing now makes sense. Also, if income tax rates increase, current yields will be even more attractive on an after-tax basis.

If you purchase individual municipal bonds and hold them to maturity, you will not have to worry about changes in principal value. You will receive all of your principal when the bond matures. And at this point in time, the yields of even the highest-quality municipal bonds are attractive. If you want to reduce your risk, you can purchase intermediate-term muni bonds with investment-grade credit ratings.

April 27, 2009

Using Buy-to-Let for Investment Purposes Requires Effort

With the number of available buy-to-let properties on the rise, landlords need to step up their game a pace. Letting an apartment or home is becoming more competitive as the number of buy-to-let investors has risen over the last few years. As it is, the number of properties awaiting tenants still outpaces the number of people looking to rent one. That being said, the credit crunch has ensured that a steady flow of would-be tenants will continue for quite some time.

Therefore, any landlord looking to develop a long lasting buy-to-let investment portfolio needs to do his homework before purchasing his properties. This involves a bit of legwork in determining which locations and which types of properties are more likely to be popular. Seasoned landlords already have much of this information at hand. However, new buy-to-let investors need to develop a sense of where to purchase as well as when to purchase.

Additionally, landlords must become vigilant about keeping the buy-to-let property in good working order with an attractive appearance. As with buy-to-own properties, these rental units must be fully functional for the number of individuals that they are intended to house. Appliances must be in good working order and the rental units must be clean prior to letting them out.

However, not only must landlords stay on the alert for necessary repairs or upgrades to their buy-to-let homes and apartments, but also, they must watch their expenses in this new climate of expensive mortgages and tenants struggling to make ends meet.

April 23, 2009

Making Sure that Bankruptcy is the Best Option for You

Bankruptcy allows people to make arrangements for paying off or eliminating their debt through a legal process that is not at all simple. Any bankruptcy case will involve courts and filing for one will involve a number of consequences. This is the reason why it should not be seen as the easy way out of financial obligation.

Because it does affect people's credit ratings for many years, bankruptcy should be considered as the last option taken by those who are truly desperate. If you currently find yourself in financial trouble, think about your other options before you decide to file for bankruptcy. Some of these options include debt counseling, debt re-negotiation, and debt consolidation. However, if these are all options you have explored to no avail you may start to believe that bankruptcy is truly your only way out of your financial trouble. Before you declare bankruptcy, consult a financial professional and determine if it is really what you need to do.

The first step you need to take in order to determine if declaring bankruptcy is truly the right option for you is to gain as much knowledge on it as you can. Read up on bankruptcy laws and processes. You may also want to consult professionals as well as others who have already gone through the process. When it comes to the law, you should know that Chapter 7 and Chapter 13 are the two kinds of bankruptcies that are available to you as an individual. Businesses and organizations are covered by other types.

Educate yourself about Chapter 7 and Chapter 13 completely. You want to be completely knowledgeable about your rights, obligations, and choices no matter which type you will have to choose. You should also determine the rights of your creditors under each type. Understand what they may be entitled to and how they will be involved in the procedure. Apart from these, you must learn the process of both types and find out how each will affect your current financial situation as well as your future credit rating.

After getting educated about bankruptcy, you will most likely want to avoid it and re-explore your other options. You can choose debt consolidation where all debts are lumped together and settled through one monthly payment. For instance, if you're thinking of going bankrupt because you are just a little short with your payments every month or you find it difficult to manage your debt, this option may work well for you. You can also communicate with your creditors and try to work out payment arrangements with each of them.

As you can see, there are other options available to you than simply declaring bankruptcy. Be sure you determine that the other options are truly not for you before deciding to go file for bankruptcy.

The key lesson here is that bankruptcy is not for everyone and should not be taken in haste. Explore all of your options and ensure that filing for one is the best decision to make. Bankruptcy should be the last road taken when in financial distress since it will likely make things like securing a mortgage much harder in the future.

April 17, 2009

How Much Money Do You Need for Retirement?

One of the most critical factors in determining how much you need to accumulate by retirement age is how much annual income you'll need in retirement. But if that retirement date is years or decades away, it may be difficult to come up with a reasonable estimate of your income needs. Most people will want a standard of living similar to the one they're living before retirement; so simple rules of thumb, like 70% of preretirement income, may not give you an accurate estimate. Follow these tips to estimate how much money you will need:

Add up your current expenses. Make sure the list is as complete as possible, including regular monthly expenses as well as irregular, periodic expenses, such as insurance premiums, tuition, and gifts. If you've prepared a detailed budget, much of the work will already be done. If you don't have a budget, most of the information can be found by examining cancelled checks, credit card bills, and tax returns. If you can't account for more than 5% of your income, you may need to take a closer look at your cash purchases.

Estimate which expenses won't be incurred in retirement. Once you retire, you won't need to save for retirement anymore. Other expenses that are likely to go away include commuting costs, some clothing expenditures, and meals while working.

Determine what additional expenses to expect after retirement. This will depend in large part on how you plan to spend your retirement years and will typically include items like travel and entertainment. At this point, you want to plan for your ideal retirement lifestyle. Don't forget to consider health-care costs. Even if you qualify for Medicare, most people incur substantial out-of-pocket costs.

Decide which expenses you can cut back on. This analysis will become critical if you can't afford your ideal retirement. Break down your expenses between essential and discretionary. Essentials will include food, utilities, health care, transportation, and housing. Discretionary could include travel, entertainment, and purchases of luxury items. Cutting back on discretionary items is not your only alternative. Perhaps you can move to a smaller home or pay off your mortgage, both of which could dramatically lower your expenses. Or, you might only need one car instead of two after retirement.

Once you decide how much retirement income you need, you can calculate how large a nest egg you'll need at retirement. Be as accurate as possible, since overlooking just one or two items can significantly change the income you'll need

April 13, 2009

Encourage Your Child to Fund an IRA

Once your child starts working, help him/her develop good savings habits by encouraging him/her to fund an individual retirement account (IRA). Even if your child only contributes for a few years, an IRA can provide significant funds for retirement.

Your child must have earned income to contribute to an IRA and may only contribute the lesser of earned income or the maximum IRA contribution. The maximum limit is $5,000 in 2009 and 2010. Due to tax law provisions, the limit will be reduced to $2,000 in 2011 unless further legislation is enacted.

Assume your 16-year-old daughter starts working part-time. If she contributes $2,000 to an IRA from the ages of 16 to 22, she will contribute $14,000 over seven years. With no further contributions, the IRA could potentially grow to $527,437 on a tax-deferred or tax-free basis by age 65. That assumes earnings of 8% compounded annually but does not include any income taxes that might be due.

If your child continues $2,000 IRA contributions until age 65, she would make total contributions of $98,000 and could accumulate investments of $1,145,540. (These examples are provided for illustrative purposes only and are not intended to project the performance of a specific investment vehicle.)

Although most children will be eligible to contribute to both a traditional deductible IRA and a Roth IRA, you should probably encourage your child to fund a Roth IRA, which has several advantages:

Roth IRAs are more flexible. Your child can withdraw all or part of his/her contributions at any time without paying federal income taxes or penalties. Thus, if your child later decides to use contributions for college, a car, a down payment on a home, or for some other purpose, contributions can be withdrawn with no tax consequences.

Earnings accumulate tax free, plus qualified distributions can be withdrawn tax free. A qualified distribution is one made at least five years after the first contribution and after age 59 ½. There are also certain circumstances where earnings can be withdrawn without paying income taxes and/or the 10% federal income tax penalty. If your child allows the funds to grow until at least age 59 ½, all contributions and earnings can be withdrawn without paying any federal income taxes.

A traditional deductible IRA offers little tax benefit to a child. When your child first starts working, he/she will typically pay a low marginal tax rate on his/her income. So even though the Roth IRA contribution is not tax deductible, your child typically receives little or no tax benefit from deducting the traditional IRA contribution anyway.

If you can't convince your child to use his/her own money to fund the IRA, consider reimbursing him/her, as part of your annual gift tax exclusion, for any IRA contributions. Hopefully, you will also teach your child some important lessons about saving at an early age.

April 7, 2009

What's Your Credit Score?

How is it that you can apply for a mortgage, credit card, or car loan over the phone and be approved or declined in a matter of seconds? For speedy access to credit -- and the mountain of credit card "preapprovals" you get in the mail each month -- you can thank an invention called the FICO score.

Your FICO score is the most common type of personal credit score, used in some form by most lenders. The FICO score tells lenders in a very simple way how likely you are to repay your debts on time. Ranging from 300 to 850, your FICO score is calculated according to a formula developed by the Fair Isaac Corporation (hence the acronym "FICO").

What everybody wants, of course, is a high score -- the higher the better. With higher scores come lower interest rates. How do you get a higher FICO score? First, you need to know the factors that influence your score. In order, they are:

How you pay your bills (35 percent of your score). How consistently have you made your payments on time? If you've paid bills late, how many times were you late? How late were you? How much money did you owe? Have you ever had a debt in collection? What was the size of the debt? Have you ever filed for bankruptcy?

Your total outstanding debt (30 percent). Outstanding debt is debt of all kinds, including mortgages, car loans, credit cards, home-equity lines of credit, and any other loans that are reported to a credit agency. Another important factor here is how much unused but available credit you have on your credit cards. The absolute amount of available credit you have is less important than how close you are to maxing out the credit you've been granted. The highest scores go to people who use credit sparingly and keep their balances low.

The length of your credit history (15 percent). The longer you've had and used credit, the higher your score. You get even more points if you have established long-term credit with the same lenders -- a reason why you might not want to close long-term credit cards, even if you don't use them very much.

Mix of credit types (10 percent). Your score is higher if you have a variety of fixed payment loans and revolving credit.

Recent applications for credit (10 percent). A number of applications for credit over a short period of time raises a red flag for lenders, as it is often a sign that a person is in a cash flow crisis. The FICO formula takes points away for this. Multiple applications for a specific type of credit in a concentrated time frame -- when you're rate shopping for a mortgage, for example -- don't count against your credit score.

What doesn't have an effect on your credit score? Demographic data like your age, sex, race, education, marital status, and how long you've held your job or lived in your current home. Perhaps surprisingly, your income and whether you've ever been turned down for credit also have no bearing on your credit score.

How to Raise Your Score

Just as there are things you can do that will lower your credit score, there are also things you can do to raise it, including:

• Pay your bills on time.

• Make more than the minimum payments, especially toward credit card accounts with balances close to your credit limit.

• Transfer a portion of the balances you have on cards that are nearly maxed out to cards where you are well below the limit.

• Challenge any inaccuracies on your credit reports. You're entitled to a free credit report every year. Check it at least that often to guard against mistakes.

April 3, 2009

Reevaluate Your Portfolio

With the recent market declines, it may be painful to reevaluate your portfolio in depth, especially if your portfolio contains large losses. But this review is necessary to see if changes are needed to your portfolio. Below are 4 factors to consider:

Measure the performance of each investment in your portfolio. Many investments and investment managers will provide you with periodic performance information. If you invest in individual stocks and bonds, you may need to calculate those returns yourself. Your total return equals the change in market value plus any dividends, interest, or capital gains, divided by the beginning market value. Total return can be difficult to calculate, especially if you make additional investments or withdrawals during the year.

Compare each component of your portfolio to an appropriate benchmark. A wide variety of market indexes now exist, covering many different segments of the market. You should be able to find ones that track investments similar to each component of your portfolio. Making comparisons to a benchmark should help identify portions of your portfolio that may need changing or that you want to start monitoring more closely.

Calculate your overall rate of return, comparing it to your estimated return. When designing your investment program, you probably assumed a certain rate of return, which determined how much you needed to invest to achieve your financial goals. Calculating your actual return will determine if you are on track. With the recent market declines, you are likely to find you have not made that much progress or may have lost ground over the past couple of years. In that case, you need to take a fresh look at your financial goals and your current investments, and then recalculate how much you should be saving on an annual basis to reach your goals.

Review your overall allocation to determine whether changes are needed. This annual review is a good time to compare your actual allocation to your desired allocation. You may find you need to make changes for a variety of reasons. Over time, you will find your allocation shifts due to varying returns on different assets. You may also need to sell certain investments that are not performing well. Your asset allocation is likely to need refinement, since your strategy will change over time.


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