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November 30, 2009

How to Grow Your 401(k) Plan

Your 401(k) plan's ultimate size is primarily a function of two factors -- how much you contribute and how much you earn on those contributions. Of course, you know you should contribute the maximum amount possible ($16,500 in 2009 plus a $5,500 catch-up contribution for individuals over age 50, if permitted by the plan). But what steps should you take to maximize your returns right now? Consider these five tips:

Take advantage of employer-matching contributions. Contribute at least enough to take full advantage of any matching contributions. You simply lose the money if you don't use it. A 50% match on your contributions is the equivalent of earning 50% on your money in the first year. If you plan to contribute the maximum and your employer matches contributions, have the $16,500 taken out of your pay uniformly throughout the year. Most employers match your contributions as they are made, so you could forego some matching if you reach the limit before year-end.

Select your investment alternatives carefully. Since you are responsible for investment decisions, understand all alternatives and review all available information before making choices. Keep in mind the long-term nature of your retirement goal and select investments for that time period. For most participants, despite the substantial declines in the stock market over the past couple of years, that will mean that a significant portion of their portfolio should be invested in growth alternatives such as stocks.

Rebalance periodically. Numerous studies have found that rebalancing reduces portfolio volatility, often with increased returns. By rebalancing, you are following a fundamental investment principle -- you are buying low (those investments that are underperforming) and selling high (those investments that are performing well). Keep in mind that you set your asset allocation strategy because you believed those were the appropriate percentages of various investments that you should own. Thus, you need to make rebalancing a habit so your portfolio doesn't become more risky than intended. Since your 401(k) plan is tax deferred, there are no tax ramifications to buying and selling within the account.

Limit the amount of company stock owned. Purchasing too much company stock is risky. Not only is your job and livelihood tied to the company, but your retirement savings are also tied to that same company. It is generally recommended that any one stock not comprise more than 5% to 10% of your portfolio's value. If you own company stock in your 401(k) plan, look at how much of your total balance it represents. Take steps to immediately reduce that percentage if it is over 10% of your total portfolio.

Don't borrow from your 401(k) plan. While it may be comforting to know you can gain access to your 401(k) fund when needed, only borrow as a last resort. It's true that you are borrowing from yourself and will pay interest to yourself, but there are also hidden costs to this borrowing. When you borrow, some of your investments are sold. While your loan is outstanding, you miss out on any capital gains or other income those investments would have earned. Interest rates are typically very reasonable with 401(k) loans, often prime rate or a couple of points over prime. That makes it easier to pay back the funds but could mean your 401(k) account is earning lower returns than if it was invested in other alternatives. Also, if you leave the company while a loan is outstanding, you must repay the entire balance within a short period of time or the loan will be considered a distribution, subject to income taxes and the 10% early withdrawal penalty if you are under age 59 1/2 (55 if you are retiring).

November 25, 2009

Why You Should Have an IRA

In some ways, a 401(k) plan or defined-benefit plan from an employer can provide a false sense of security. You may feel, without analyzing the situation, that you're saving enough for retirement. But the reality is that the plan may not be enough to provide the retirement you had in mind. Thus, you may also want to contribute to an individual retirement account (IRA) for some or all of the following reasons:

You'll probably need the additional funds for retirement. Even with Social Security and pension or 401(k) benefits, you'll probably need other savings to fund your retirement. There are a variety of ways to save, but an IRA can be a good alternative for retirement.

You'll lower your taxes. You can lower your taxes currently by contributing to a traditional deductible IRA or in the future by contributing to a Roth IRA. With a traditional deductible IRA, you receive a tax deduction on your current year income tax return. When you withdraw the funds in the future, you'll owe ordinary income taxes on the contributions and earnings. With a Roth IRA, you don't receive a current year tax deduction, but qualified distributions are withdrawn without paying any federal income taxes.

You're more likely to use the funds for retirement. If you save in a taxable account, it's easy to use the funds for other purposes. However, the government discourages the use of IRA funds for other purposes by assessing a 10% federal income tax penalty when funds are withdrawn before age 59 ½ (except in certain limited circumstances). That makes it more difficult to withdraw the funds and more likely they'll stay in the IRA.

You have a wide variety of investing options. With a 401(k) plan, you typically have a limited number of investment options. However, with an IRA, you can invest in a wide variety of investments.

November 18, 2009

Assessing Your Life Insurance Needs

Life insurance is meant to protect your family in case you die. We all hope to live to a ripe old age, to see our grandchildren marry and have children of their own, and to share old age with our spouse. But life insurance is about preparing for the unexpected. If you have dependents who rely on your income, life insurance will probably be needed to provide for them after your death. Consider these five steps to ensure you have the right life insurance coverage:

1. Determine how much life insurance you need. To decide, consider:

• What lifestyle do you want to provide for your spouse and other dependents?

• How much will that lifestyle cost?

• Are there any special circumstances you should consider, such as paying for a child's college education, paying off a mortgage, taking care of elderly parents, or providing for your spouse's retirement?

• What other sources of income are available to pay for that lifestyle?

2. Decide what type of policy you need. Although there are a wide variety of policy types, the two broad categories are term and cash value:

Term insurance -- With term insurance, you purchase insurance protection only, with none of the premium set aside to build cash value. Your beneficiary receives the policy proceeds if you die during the policy's term, but you get nothing if the policy is canceled.

Cash-value insurance -- Cash-value insurance accumulates, from premiums paid and from investment earnings, a cash surrender value that is your property. If you surrender the policy, you receive that value. Furthermore, you can borrow against the cash value through a policy loan, but any outstanding loans are subtracted from the insurance proceeds when you die. A wide variety of cash-value insurance policies exist, with numerous riders available to meet specific needs.

3. Review insurance policies. Since life insurance companies offer so many different options, it can be difficult to compare several different policies. Try following these steps:

• Compare only the same type of policy. For instance, don't compare a term policy to a variable life or whole life policy.

• Make sure the policies contain the same options and riders.

• If considering permanent insurance policies, review the assumptions used in the policy illustration, which shows the policy's projected value at some time in the future. Keep in mind that these illustrations are hypothetical and your value will depend on the policy's actual performance. Obtain illustrations based on three alternatives -- the original illustration, one with an interest rate 1% lower than anticipated, and one with the minimum guaranteed rate.

4. Take the time to understand what you are purchasing. Life insurance policies are complex documents. Make sure to read the entire contract, and get answers to any of your questions. Don't sign the policy if you don't understand its terms.

5. Periodically reassess your policies. Your life insurance needs will typically change over your lifetime. If you've married or divorced, had a baby, or your spouse died or became disabled, you'll likely need to change your life insurance coverage. Make time each year to reassess your current life insurance policy.

November 11, 2009

Reviewing Your Homeowners Insurance Policy

Often, homeowners insurance is purchased with the home and then is not thought about again until a claim is made. But since there is little you can do at that point about your coverage, take time periodically to review your policy. Below are a few items to consider:

Review the adequacy of your policy limits. Investigate how much it would cost to replace your home and make sure your policy limit will cover that amount. Don't insure your home for its market value -- it may cost more or less than that to rebuild your home. And even if your home were totally destroyed, you would still have the land. Try to obtain guaranteed replacement cost coverage, where the insurance company will rebuild your home even when the cost exceeds the policy limits. Be aware, however, that some companies no longer offer this coverage and even those that do define guaranteed replacement cost in different ways. Some companies will rebuild your home no matter what the cost, while others cap their coverage based on a certain percentage of the policy's face value. Make sure your policy has an inflation endorsement that increases your coverage annually for increases in construction costs.

Obtain coverage for special risks. Basic policies protect you from fire, smoke, windstorms, vandalism, and lightning. The most comprehensive policies cover every peril except those specifically excluded, typically floods, earthquakes, war, and nuclear accidents. If you live near a flood plane or earthquake area, obtain specific coverage for these perils. Find out if your policy will pay to rebuild your home in accordance with local zoning laws and ordinances. An existing home does not have to meet new zoning laws and ordinances, but when you rebuild, you must comply with those laws. Unless your policy specifically covers that cost, your insurance company will typically only pay to rebuild your home based on its previous condition.

Understand what other items are covered by your policy. Your homeowners policy also typically covers personal property, other structures on your property, landscaping, loss of use when your property is destroyed, and personal liability coverage. Carefully review the limits for all of these items, since you can generally add endorsements if you need additional coverage. Typical policies cover personal property for a maximum of 50% of the coverage on the home, usually paying actual cash value, which deducts depreciation from the amount paid. Try to obtain a replacement cost endorsement, which pays to replace your property and typically raises the limit to 70% of your home's coverage. Pay special attention to limits for items like jewelry, antiques, collectibles, and works of art.

How to Reduce Premiums

While you do not want to skimp on your homeowners insurance coverage, it is possible to obtain appropriate coverage and save money at the same time. Insurance companies offer discounts for a variety of reasons. Consider the following tips to help save on your homeowners insurance premiums:

• Use safety features in your home, such as fire alarms, carbon monoxide detectors, fire resistant doors, motion sensors, and security systems.

• Increase your deductible, which can significantly lower your premium. If you do so, however, keep an adequate emergency fund to cover higher out-of-pocket costs for any claims.

• Ask about discounts for using the same insurance company for other insurance needs, such as auto, life, or health.

• Stay with the same company. Insurance companies will often give loyalty discounts to customers who have stayed with the company for years, although you will typically have to ask for this discount.

• Maintain a smoke-free environment. Insurance companies will often lower premiums for households that are smoke free.

November 5, 2009

Unemployment During a Recession

With unemployment rates higher than they've been in decades, many are trying to determine how quickly unemployment numbers will come down once the recession is over. While the overall unemployment rate is the most commonly cited statistic, researchers focus on two components of that rate -- the inflow rate, or the rate that workers are moving into unemployment, and the outflow rate, or the rate that workers are moving out of unemployment. The movement of these two rates has varied over time.

During recessions in the 1970s and 1980s, increases in the rate that workers were moving into unemployment and decreases in the rate that workers were moving out of unemployment were nearly equivalent. In other words, during these recessions, employees were getting fired and were unable to find new jobs because employers were not hiring. This caused large spikes in the overall unemployment rate. However, once the economy turned around, the inflow and outflow rates returned to normal levels, bringing the overall unemployment rate down very quickly.

But during the 1991 and 2001 recessions, unemployment rates spiked up primarily due to lack of hiring, not due to massive layoffs. As the economy started to recover, employers were slow to hire, creating jobless recoveries.

During the current recession, the labor markets are again more typical of recessions in the 1970s and 1980s, with high levels of firing and low levels of hiring. That makes it much more difficult for unemployed workers to find jobs, increasing the length of time people remain unemployed.

To try to determine how much hiring employers will do once the economy starts to recover, a couple of other indicators can be reviewed. During recessions, the number of temporary layoffs and the number of involuntary part-time workers typically increases. However, during this recession, there are more permanent, rather than temporary, layoffs, meaning that employers do not intend to rehire these employees in the near future. For instance, between July 1981 and November 1982, the percentage of unemployed workers on temporary layoffs increased from 16.1% to 20.7%. From December 2007 to April 2009, the percentage declined from 12.8% to 11.9% (Source: FRBSF Economic Letter, June 5, 2009).

The number of employees who are working part-time involuntarily is at historical highs, increasing from 3.0% in December 2007 to 5.8% in April 2009 (Source: FRBSF Economic Letter, June 5, 2009). This increase has occurred in a broad range of industries in a wide range of occupations. Many see this as a sign that once the economy recovers, employers will just move employees from part-time to full-time status, without the need to hire more employees.

While no one knows for sure what will happen in the future, all of these factors imply that even when the economy starts to recover, unemployment rates may stay at high levels for some time to come.


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