David McPherson Answers Your Money Questions

Oct. 27, 2008— -- Terry from Parker, Colo., asked: "Is it really best to stay in the stock market when it appears the economy will take many months to recover? Each day we hear that getting out of the market is the wrong thing to do. Like many others, our retirement fund has recently lost nearly a third of its value. We are already retired and are fearful that we will continue to lose more money if we stay in the market. Is it advisable to sell our stocks and keep the funds in a money market account until the economy improves and we can get back into the stock market? Thanks for your help."

McPherson answered: Terry, the answer to your question depends upon on when you expect to need these funds. Any portion of your retirement fund that you expect to need within the next three to five years should not be invested in stocks. Rather, it should be stashed in a money market account, bank CD or some similar conservative holding. If you're willing to accept a little more risk, a short-term bond fund may also be appropriate for a small portion of these funds.

If there's a portion of your overall portfolio that you want to grow and don't expect to need for at least five years, then a modest allocation to stocks is appropriate.

What I would do is rather than view your portfolio as a single entity, look at it as an array of portfolios designed to meet short-, medium- and long-term needs. Then invest accordingly.

I would also advise against trying to guess the right time to get in or out of the market. That's a losing game.

Diane from West Deptford, N.J., asked: "I retired last year at the age of 55 with 38 years of service with a large corporation. My husband is also retired. I rolled over my 401K upon retirement. Currently 68 percent is held in equities, 30 percent in bonds and 2 percent cash is reinvested. I don't planning on using this money for at least five years. I am, like everyone else, losing money. Should I look at redistributing my money; moving more over to the bond side or let it remain the same?"

McPherson answered: Diane, a 68 percent allocation to stocks might be a tad aggressive for some investors in their mid 50s, but if you have a reliable pension from your former employer, then it sounds about right to me. Investors with a guaranteed income stream from something like a company pension can afford to take more risk than those who rely entirely on their nest eggs to cover expenses.

As I suggested to Terry above, I would take a look at when you think you will need the funds rolled over from your former 401(k). You mentioned withdrawals would begin in five years. The portion you might withdraw in the early years should be invested more conservatively. It does sound to me like you need a little more cash in that portfolio. Two percent is a little light by my standards. I would take that up to about 10 percent, maybe drawing a little bit from both the bond and stock sides.

Overall, I think you're in the ballpark, but you need to consider your own income needs and your appetite for risk.

Doris from Uxbridge, Mass., asked: "I am planning on retiring within the next year and a half -- would I be better off withdrawing my investment money and paying the penalty?"

McPherson answered: Doris, The short answer: No. Based on your question, I'm assuming you're under age 59 and-a-half, and that's why you're asking about paying a penalty on your retirement funds. If you're uncomfortable with your investment portfolio, you can lower the risk level in your portfolio without incurring an early withdrawal penalty.

If the money is in an IRA, you can easily invest all or a portion of your portfolio in lower-risk options like bonds or cash. In an employer-sponsored plan like a 401(k) or 403(b), your investment options are dictated by your employer. But most employer-sponsored plans include bond and cash options.

Above all else, I would avoid a withdrawal that incurs taxes and penalty. A hasty, premature withdrawal from a retirement plan can easily cost you 40 percent or more in taxes and penalties depending upon your tax bracket and the state in which you live.

Edra, from Fort Wayne, Ind., asked: "The 401K has lost over $30,000 -- my husband is 55, I am 57. Should we keep contributing or should we pull out the remaining money and put into a savings or money market account or CD? Seems like the contributions are just disappearing. Any recommendation would be appreciated."

McPherson answered: Edra, as I told Doris above, I would avoid making an early withdrawal that would trigger taxes and penalties. You should be able to shift to more conservative investment options within the 401(k) plan if you think that's best and still avoid a 40 percent-plus hit like I mentioned above.

On the question of whether you should keep contributing, the answer is absolutely. If you stop contributing now and then resume later after the market has recovered, then you're just buying mutual fund shares at a higher price than what's available now.

Remember, buy low, sell high. And right now, stock and mutual fund prices are the lowest they've been in a while.

So I understand the desire to maybe shift to more conservative investments, but stopping your contributions would absolutely be the wrong move. In fact, one way to recover from the current market is by stepping up contributions so you can buy even more of these cheaply priced shares.

Erika asked: "I am a 54-year-old, I had $100,000 in my 401(k) and now have $50,000 left. Would it be in my best interest to pay off my mortgage of $50,000 and then take that monthly $500.00 and start a new 401(k)?"

McPherson answered: Erika, I would not suggest using your 401(k) funds to pay off your mortgage. The primary reason is that at your age, you would incur a 10 percent early withdrawal penalty plus ordinary income taxes on the amount withdrawn. As I mentioned to others above, you could lose 40 percent or more of your remaining balance to taxes and penalties. That means after setting aside money for those, you would not have enough money left to pay off the mortgage.

If you have other funds available in a taxable account that could be used to pay off the mortgage, that might be something to consider. You would want to look at the interest rate you're paying on your mortgage and the number of years left on the mortgage.

If you're deep into the term of your mortgage, chances are most of your mortgage payment is going toward paying down the principal rather than interest payments. That would be another reason not to pay off the mortgage all at once.

Overall, you have the right idea about contributing more to a 401(k) plan, but you'll be in an even deeper hole if you pay off the mortgage using what's left of your retirement account.

Rebecca, from Prairie Village, Kan., asked: "I am 56 years old and make $56,000 a year. I have lost quite a bit of my 401(k). How much should I be putting into it each month? My employer puts in 8 percent."

McPherson answered: Rebecca, at 56, I would try to put as much as humanly possible into your 401(k) plan, particularly if your employer is matching your contributions up to 8 percent of your salary. That's quite a generous match.

If you put in 8 percent of your salary and your employer matches that dollar for dollar, that's an immediate 100 percent rate of return on your investment. There's no other way to generate that kind of return. Also, keep in mind, the shares you're buying now through your 401(k) contributions are being bought at depressed prices. That's all the more reason to keep contributing.

For 2008, a 56-year-old employee can contribute up to $20,500 to a 401(k) plan and next year that will go up to $22,000, the IRS recently announced.

If you can contribute anywhere near that amount, I'd give it some serious thought.

Cindy, from Weaverville, Calif.: How long are money market accounts insured? Is there a maximum amount? Where is the safest place to put money when using a SEP or a 401(k)?

McPherson answered: Cindy,When asking about money market account insurance, I assume you're talking about the guarantee program for money market mutual funds announced by the U.S. Treasury in September when the current financial crisis began to unfold.

The guarantee program is scheduled to be in place until Dec. 19, but the Treasury Department has the option of extending it. There is no limit on the amount guaranteed. However, the guarantee only applies to funds invested in a given fund as of Sept. 19 when the program was first announced. Additional fund shares bought since then do not qualify for the guarantee.

One last qualifier: The decision on whether to participate in the guarantee program rested with the fund companies that operate money market mutual funds. Check with the company that operates your money market fund to see if it chose to participate and pay the associated cost.

Lizeth from Fresno, Calif., asked: "I have a 80 percent-20 percent home loan with a balloon payment on my 20 percent loan. I want to know if there is anything I can do get my loans into one. My house payment is $2,300 a month. My 80 percent is a 30-year fixed rate at 6.8 percent. My 20 percent is 15-year with a 8.2 percent rate. I have two different loan companies, Countrywide and American Serving. How do I get both loans in one?

McPherson answered: Lizeth, I would contact both lenders that issued your existing loans to see what your options are. What you want to do is to refinance into a single consolidated loan. In the current loan market, you could have a tough time, depending upon the value of your home, your income, your credit record and other issues.

I would also begin contacting other established mortgage lenders in your area to explore your options. It's unclear to me when your balloon payment is due. Sounds like it might be a ways away, but I would get started on this now. It could take a fair bit of effort on your part, Good luck.

Steven, from Wellsville, N.Y., asked: "I am 60 years old and am getting retirement pension payments from my Kmart Corporation administered by State Street Financial. How can I tell if my pension is in jeopardy? Are pensions protected by the government?"

McPherson answered: Steven, yes, pension plans like the one it sounds as if you have are guaranteed by the federal government in the form of the Pension Benefit Guaranty Corporation. There is a limit on the pension amount guaranteed. The current limit is $51,750 a year. For most retirees receiving smaller amounts, that's plenty. But some retirees from high-wage jobs could lose some of their benefits if their pension plan runs into trouble.

I'd suggest a visit to the Pension Benefit Guaranty Corporation's Web site, www.pbgc.gov, to learn more about the guarantee program.

For information about the health of your pension plan, you might want to review the public financial statements of Kmart's current owner, Sears Holding Corp. These filings are available through the Securities and Exchange Commission Web site, www.sec.gov., and other sources.

Robin Connell, from Stewartsville, Mo., asked: "My husband, age 71, has retired but still works part time and earns about $16,000 per year. I teach school -- earn $34,500 and am five years from retirement. About one year ago we moved almost all of our 401(k) money ($200,000) to money markets and Stable Value funds, thankfully. However, I know at some point we need to get back into the market just to keep up with inflation. What kind of investments should we be considering for our investments which have now been put into IRAs? And, what is the best way to start moving back into the market?

McPherson answered: Hi Robin, I think you're correct to think about reinvesting some of your money. It's tough for me to say exactly how much should be reinvested without knowing more about your situation. But in general I'd suggest you consider low-cost index mutual funds or exchange traded funds, both of the stock and shorter term bond variety. You want to create a well diversified portfolio that includes both domestic and international investments. The key question to consider is what percentages should be dedicated to stocks, bonds and cash. That's something only you can consider.

As for the best way to reinvest, it sounds like in your case a series of small steps is the way to go. Rather than invest all $200,000 at once, break it down into a series a purchases so that if the market continues to fall, you're not too exposed. But I think now is a good time to start given the low prices we see now. You don't want to miss out on the current buying opportunity, but you also don't want to over commit yourself given the current environment. Good luck.