Wednesday, December 16, 2009

An Early Christmas Gift to my Engineering Friends! The Difference Between Arithmetic and Geometric Averages in Finance?

What is the Average rate of return? For most people this is the very question that will determine whether or not they put their money in a particular investment. How someone determines that average rate of return number however can tell a completely different story about the investment. The link below talks about the difference between arithmetic and geometric averages. Arithmetic averages are what most of us used to use to determine our grade in school. However, in finance arithmetic averages can hide the true performance of an investment.

If someone is trying to sell you on an average rate of return be sure to ask them if they calculated that using an arithmetic or geometric average (and probably watch their eyes glaze over).

The formula below shows how to calculate an annual geometric compound average rate of return on an asset invested as a single lump sum (this is only for lump sums, and would not work for something you are making ongoing deposits, like a 401k).

(((Current Asset Value/Original Asset Value)^(1/Number of Years Compounding))-1)*100= Average Percentage Compounded Return

As an example say you originally had $100,000 in an IRA 8 years ago and today it is worth $150,000. Your average annual compounded rate of return is 5.1990%

See the Article Below for the Difference Between Arithmetic and Geometric Averages:

Friday, November 6, 2009

401k- Easy to Put Money In..Hard to Get It Out

How much to put in my 401k/retirement plan? That is a question almost everyone who has a job thinks about from time to time. There are better ways to get to a decision than taking advice from a TV personality, your company match, or a co-worker. I think one factor in your decision making process should be the following:

Take the number 60 - (Your Age). Then decide am I okay giving up the freedom, control, and use of this money for this many years or more (could be more according to your plan document or if the government changes the rules).

If you have a 401k or similar retirement program at your work just remember these plans make it easy to put in your hard earned money. Remember once your money is there it is very difficult or maybe even impossible to get it out. You have to follow not only the current government rules, but also the company's 401k rules as well.

So before you put your hard earned money in your company 401k know the rules. Also, be open to other alternatives outside of government sponsored plans that might be of more benefit to you and your family.

Friday, October 30, 2009

Let's Talk About Money: A Scary Call to Action

A scary call to action

One of the number one causes of divorce in our country has its roots in our relationship with Money and Finances. These times are especially difficult for those that are out of work. Money is just a commodity resource that we use to get through life. No man or woman is better or worse for having more or less of this commodity.

It surprises me the number of hard-working, well meaning people who will work 40-60 hours a week yet not even spend an hour going over their finances. Even worse, fewer take the time to discuss their family finances with their significant other. I relate to this first hand. Growing up my parents thought talking about money was taboo, and rude. In the past talking about it became a point of stress in my own life.

I'd to challenge anyone reading this to make it a point to review your own situation on a periodic basis. If you are married share this with your spouse as well. If you have teenagers or young adult children maybe get them involved.

Thursday, October 22, 2009

3 Reasons Everyone Should Demand an “In-Service Withdrawal” Provision in Their 401k Plan?

Almost all 401k participants are unaware that they can legally remove a portion of their 401k into their own self-directed IRA, without penalty or taxes, and without quitting their job. This is provision is most commonly known as an “In-Service Non-Hardship Withdrawal”. However, most 401k plan administrators do not put this provision in many company’s 401k plan documents. It’s my belief they do not have this provision for fear of losing assets by which they can continually collect fees from plan participants (employees). Below are 3 reasons why all employees should demand an “In-Service Withdrawal” provision in their company sponsored 401k plan:

#1) More Options:

Money removed can be put in any savings vehicle that allows for IRA (Individual Retirement Account) contributions. This means that participants are not limited only by the choices in their current 401k plan. With your own IRA you are in control of your money!

#2) Reduce Fees:

According to the Department of Labor there are up to 17 fees a 401k plan administrator can charge. Even worse they found that 78% of workers did not know what fees they were being charged in their 401k.

#3) Safer Options:

Many articles are coming out stating that the 401k system is simply broken (see links below). A common complaint is there are no safe options available. There are many safe places you can put an IRA today, including some that will guarantee you an income for life in retirement (just like granddad’s pension).

In conclusion, like most people I prefer options as opposed to a one size fits all approach. An “In-Service Withdrawal” provision gives these options. Without this provision you are stuck with whatever choices your employer provides.

Links to article regarding our broken 401k system:

Friday, October 16, 2009

What is a Fixed Index Annuity?

What is a Fixed Index Annuity?

Rarely do you hear much about fixed index annuities in the financial press. This could be due to the fact that only around 6% of all financial professionals even sale these products. I think however these financial products would be much more popular if the general public knew how they actually worked. Basically, fixed index annuities allow someone to participate in a portion of the gain in an index each year without the risk of loss of principal or previous year gains (See link #1 below to learn more about Fixed Annuities).

Recently I came across a study completed by the Wharton School of Business (see link #2 below). In this study they found that not only did the fixed index annuities outperform their risk-adverse counterparts, but also, in some cases, they even outperformed their more risky counterparts. Their study concludes that fixed index annuities were designed for safety of principal with the gains linked to a given index.

I am very grateful to have owned a fixed index annuity inside my IRA since 2006 and can tell you first hand that I have never lost $0.01 or any previous year gains. In these volatile times I think these are the type of solutions most consumers are seeking to protect their hard earned nest egg.

Link #1 to learn more about Fixed Annuities:

Link #2 to see the Wharton Study:

Friday, October 9, 2009

Before contributing a penny more to your 401k you should read this article

I ran across this article this week in Time Magazine titled "Why It's Time to Retire the 401(k)" Here is the link:,8599,1929119,00.html

Time magazine should be commended for writing such an article that goes against what I think is mainstream conventional wisdom. It raises a lot of questions that most people don't ask and 401k providers typically hide from or bury deep in paperwork.

I never understood why a lot of people put the 401k on such a high pedestal. The other thing that concerns me are the people in my generation who believe the only way they can save for the future is inside one of these government sponsored plans (See previous blog post). After dinner with a friend last night I think it may have something to do with what he called the "Subway Phenomenon". Here is how he described this Phenomenon:

Participating to your 401k, for a lot of people, is a lot like your coworkers asking you to go to Subway for lunch. You could tell them that you brought your lunch or you don't care for Subway and would like to eat somewhere else. Most likely though you just agree to go to lunch at Subway because you want to "fit" in and not look like a bad co-worker. Just like if a co-worker asked if you are maxing out your 401k and you said: "I don't contribute" or "I only do the match" or "I'm saving for the future doing something else".

Friday, October 2, 2009

Why do we willingly give up control of our money?

While driving home yesterday I was listening to a talk call-in show and during the show I heard the announcer recommend that the caller max out her government sponsored retirement plan (ie 401k/403b/IRA).

I guess to most people this would not be shocking advice but to me it was very shocking. The announcer did not ask the callers age (though she sounded fairly young 20-30's). What other debts she had (he did ask about credit cards). Or if there was any major expense coming up anytime soon.

I see what happens on the other side of this advice. The problem I have with 401k's or other government sponsored plans is that no one seems concerned about the biggest pitfall of these plans which is they essentially lock-up your money to age 59-1/2. Most of these plans have very few choices about where to put your money and many have no 100% safe options. Also as I have found out time and time again no one knows what the total fees they are being charged. Even worse almost none of these plans offer what's called an "in-service" withdrawal, so the only way to get money out of these plans is to quit or become totally disabled. Finally even after all that most of these dollars have not been taxed so if tax rates go up all of the benefits of "tax-deferral" could be lost.

What's most disturbing though for people in my generation is that contributing to a 401k actually leads to other costs (in economics they call this "Lost opportunity costs"). A couple that is 35 have $100,000 in a 401k, $100,000 in home equity and $15,000 in a checking/saving account. They need to finish their basement to move their office downstairs, so they can make room for a nursery for baby #2 upstairs. They estimated this project will costs about $50,000. Where do they get the money...their they would have to pay a 10% penalty and taxes (let alone if they even have access to it). Most likely they would get it doing a home equity line of credit. So think about this for a moment: they have made extra payments to pay down their debt only to have to pay interest on their own money again?

They pay $10,000 cash from savings and take a $40,000 loan @ 7.5% for a payment over 10 years of $474.81. Their total payments equal $56,977. Or in other words they paid a volume of interest or their "lost opportunity cost" equal to $16,977. At 5% (this is the rate of return we could gotten on our money if we had saved it and not had to spend it on interest) compounding for 40 years to age 85 (average life span) equals $125,000.

In other words because they did everything right and gave up control of their money willingly in their 401k, and to a certain extent their home equity, it costs their lifetime wealth about $125,000 not to mention the additional stress of the extra payments during those 10 years.

Wednesday, September 30, 2009

1st Blog Posting

Hello Everyone!

This is the place where I will be blogging about various topics from financial, economics, and just life in general.


Joshua Smith