Suze Orman's Action Plan (13 page)

As I explain later in this chapter, I think ETFs that focus on dividend-paying stocks are a very smart place for your stock investments today. The income you receive from the dividend is a good way to “get paid” today while still investing in stocks
for future gains. If you currently have a 50% stock investment and want to invest in dividend-paying stocks, you can make the switch over. If, however, you have a lot of money in bonds or cash, please take your time moving money into a stock ETF; rather than one lump-sum investment, make smaller monthly investments—known as dollar cost averaging—over the course of the next year.

ACTION:
If you have 15 years until retirement, have about 70% in stocks and then scale that back by 5 percentage points or so each year, so that when you are 10 years from retirement you have 50% in stocks.

ACTION:
Aim for 80% to 100% stocks. You are in a great situation. You have so much time on your hands that you can ride out this bear market and profit when the market rallies.

If you are afraid to have all your money in the
market, there is nothing wrong with keeping 20% or so in bonds/cash. With that mix, you are going to do well when the stock markets rally and also have a nice bond cushion to reduce your portfolio’s losses when the stock market is falling. If that helps you relax a bit and stay committed to a long-term strategy, I think 20% in bonds is just fine, but I’d prefer to be in stocks 100%.

ACTION:
Focus on what the market loss will mean to you in terms of monthly income.

Let’s say in 2007 you had a $250,000 retirement stash. Today it is $200,000. So what does that mean to you in terms of retirement income? Your intention at retirement was to have your money invested mostly in bonds so your money would be safe and you could count on a return of approximately 4%. The $50,000 you lost would generate $2,000 in income at a 4% rate. In other words, your real monthly loss in income comes to about $170 a month. So the question is, does that loss of $170 a month mean you can no longer retire? If the answer to that question is yes, then the truth is you really were cutting it too close to retire anyway.

The best move you can make is to delay your retirement, even by just a few years. The more time you give your portfolio to recover, and the fewer years you will rely on that portfolio to support you in retirement, the better shape you will be in. If you can keep saving for retirement during those extra few years you work, that will obviously help too. But even if you decide to take a less stressful job that does not pay as much as you currently earn—and you find it harder to save for retirement—you are still doing yourself a world of good. Every year you can live off of earned income is a year you are not requiring your retirement savings to support you. Now, I am not suggesting that you work until you are 80. But if you have set your sights on an early retirement at 60 or 62, I want you to consider working to 65 or maybe even 70, even if only part-time. Don’t look at it as punishment. It is an opportunity to live a less-stressful life, because you are not going to stretch yourself too thin. I also want you to focus on the fact that our average life expectancy keeps getting longer and longer. A 65-year-old man today has an average life expectancy to age 81, and a 65-year-old woman has a 50-50 chance of living to 84.5 years of age. That means many of us will be asking our retirement savings to support us for many years; by continuing to work until at least your mid-to late 60s, you will reduce the pressure on your savings to support you later on.

ACTION:
A reverse mortgage can indeed be a good solution, but you must understand how it works. There are some serious trade-offs to making this choice that you should be aware of.

With a reverse mortgage, the roles are, well, reversed. Instead of you paying a lender, a lender pays you a sum based on the value of your home, your age, and interest rates at the time you take out the loan. You can be paid each month, you can take out all the money in a lump sum, or you can set up a line-of-credit account from which you withdraw money as you need it. (Or you can opt for a mix of all those options.) In 2010 the upper limit for an FHA-insured reverse was $625,500.

There is no risk you will lose your house if you do a reverse. You can stay in the home as long as you like, but when you move or die, the bank that owns the reverse gets repaid. Typically that involves selling the home. If the home sells for more than the value of the reverse, your heirs receive the excess. But if the sale price does not cover the value of the reverse, your heirs will not be on the hook. The bank can never collect more than the home’s value at the time of the sale.

You must be at least 62 years old to take out a
reverse mortgage. If you are married you both must be at least 62, or you can opt to remove the younger spouse from the title.

I do not recommend a reverse if you intend to move in a few years anyway, because the fees on these loans can be very expensive. You will pay an origination fee of 2% on the first $200,000 and then 1% on the balance above $200,000, up to a maximum of $6,000 for the total origination fee. Most reverse mortgages are insured by the FHA—the FHA refers to these loans as Home Equity Conversion Mortgages (HECM)—and that means there is an insurance premium attached; it amounts to an additional up-front 2% and an annual premium of 0.5%. You’ll also be hit with closing costs on the loan, including an appraisal. All told, fees can easily be 8% to 10% of your loan amount. If you plan on staying in your home for many years, those fees can be worth it. What’s not wise is taking out a reverse when you anticipate moving in a few years.

The AARP website (
www.aarp.org/revmort
) has a special section that walks you through the basics and has valuable information on how to recognize any offers that are too good to be true. Sadly, there is no shortage of con artists out there looking to take advantage of the elderly. There is also great information available from the Department of Housing and Urban Development, which oversees the FHA reverse program. Go to
www.hud.gov
and type HECM into the search box. You can use a free online calculator to estimate how much you may receive through an FHA-insured reverse mortgage.

ACTION:
Stop worrying. The money you have invested in your accounts at a brokerage or fund company is completely separate from the operations of the parent company. The brokerage or fund company can’t use your money to pay its bills and debt.

Even if a company goes under, what happens is that you will transfer your money to another brokerage or fund company. Or, more likely, the company will be taken over and you become a client of that new company.

And just so you know, if there is an irregularity and a company uses your money fraudulently, you may be able to recover up to $500,000 ($100,000 limit for cash accounts) from the Securities Investor Protection Corp. This is not like federal insurance. It’s a voluntary program of member firms that keeps a kitty around to settle problems; at the end of 2008, SIPC had about $1.7 billion in its fund. This covers standard investment accounts only; SIPC does not cover alternatives such as currency and commodity
investments. Check with your brokerage or fund company to see if it belongs to SIPC.

ACTION:
Money invested in a variable annuity is typically in segregated subaccounts that are separate from your insurer’s balance sheet. Even if the insurer runs into trouble, your money should not be affected. Now, that said, you do need to understand that your variable annuity is susceptible to market losses; that’s what the word “variable” means. How much your account is worth is largely a function of the performance of the subaccounts (funds) you are invested in.

ACTION:
With a single-premium fixed annuity your payout is indeed a guarantee from your insurer, so if your insurer goes under there is reason to be concerned. Concerned, but not panicked.

First, in the unlikely event anything happens to your insurer, there is a state guaranty fund that will swoop in to cover annuity payments—up to certain limits. In most states, the guaranteed payout
for an annuity is $100,000, though it can be higher in some states. (Go to
www.nohlga.com
and use the locator to find your state’s insurance department, where you can learn about your state’s guaranty fund limits.)

If your annuity exceeds your state’s guaranty limit, you need to weigh the cost of cashing out carefully.

ACTION:
Consider municipal bonds and dividend-paying stock mutual funds or ETFs.

I want to be clear: You never want to put money that is in an IRA, 401(k), or other tax-deferred account in municipals. Because your money is already tax-deferred, you get no added benefit from buying munis. So I am talking about money you invest outside of your IRA and 401(k). Now, I know that earlier I told you that the bond portion of your IRA and 401(k) should be kept in Treasuries with short maturities, but I have a different strategy for municipal bonds. I think it is smart to invest in municipal bonds with maturities of 10 to 20 years. In the fall of 2009, a 20-year general-obligation municipal bond had a yield of 4.4%. For someone in the 28% federal tax bracket, that is the equivalent of a 6.1% yield. That is a seriously great return on your money. If you are in a
higher tax bracket, your return will be even higher.

As much as I love municipal bonds, I want to emphasize that this strategy only makes sense if you have at least $100,000 to invest; that is how much you need to be able to buy a diversified portfolio of five to 10 different bonds and not be hit with outrageous fees. You need to be particularly strategic these days, given the financial pressure many states and municipalities are under. I recommend sticking with General Obligation (GO) municipal bonds rather than revenue bonds (in which your payout is dependent upon the income generated by the project being financed by the bond). If you live in a state with big budget woes, it might be wise to add a few out-of-state bonds from more stable states. Yes, you may have to pay income tax on the payouts from out-of-state bonds, but having a well-diversified portfolio is more important in this environment than avoiding tax on every dollar you invest.

Another strategy to generate more income is to invest a portion of your money in high-dividend individual stocks or ETFs. The dividend payout from stocks can be a valuable income stream.

However, you need to know that dividend stocks of course have greater risk than a bank CD. Even though you are receiving a dividend payout, the underlying value of your shares can indeed fall. And there is always the possibility that some
companies might find that they have to suspend or reduce their dividend payout if they hit a severe rough patch. Indeed, according to Standard & Poor’s, in the second quarter of 2009, 250 companies decreased their dividend payouts, the worst stretch for dividend-paying stocks in more than 50 years. You need to understand that companies choose to pay dividends—they are not required to do so.

So here’s my strategy for cautious dividend investing:

• Invest only money that you know you will not need to cash in for at least the next 10 years. You will earn income (the dividend payout) on the money, but because these are stocks, you want to know that if the share price declines you won’t have to sell at a big loss.
  

• Stick with low-cost ETFs. Owning individual stocks increases your risk of suffering big losses if there is an unexpected problem in that one company or industry. It’s safer to invest in a diversified portfolio of dividend-paying stocks. I like Vanguard High Dividend Yield (VYM) and iShares Select Dividend Index (DVY) if you invest in ETFs.