Expert: Paul Henneman - 3/15/2011

Question
QUESTION: Dear Paul:

Currently, my emergency savings are, as they say, parked in a savings account (.25%) and a CD account (yield of 2.6%).  

I want to move these to higher yield accounts, but still keep it liquid so I can access it when needed.  Can you please provide some input on what you think of this option:
Money Market Funds (should I pick Tax-Exempt?): 3 months of emergency funds.
Short-Term Bonds (should I pick Tax-Exempt?):5 months of emergency funds.

Start building another account for longer term savings (these would be taxable accounts): Mutual Funds -- would you have any recommendations (I am 41)?

What is your opinion on my overall approach?  Do my % allocations and choice of investment vehicles seem suitable?

Thanks very much.

ANSWER: Thank you for your question!

Yes, I think what you are doing is fine. Every investor is different in terms of the amount of risk they are willing to take on.  The one rule in finance that I have never seen overcome is that the more returns you try to get, the higher the risk and the greater the change your investments will do poorly.  You must weigh your own needs regarding how much risk to take on.
Money market funds have very little risk.  They have low returns as well, but the low risk makes them appropriate to 'park' emergency funds.  Yes, they are very liquid and you can typically get at these funds with little to no delay.
Short term bonds are relatively low risk, but do have some risk should the markets do extremely poorly. Panic can affect even the safest investments.  But overall, they can be considered low risk and should have a higher return than the money market funds.

Have you considered true retirement savings accounts, such as a ROTH IRA account? These have significant tax advantages down the road, as the funds you deposit grow with no taxes due for investment profits, and then no taxes typically for withdrawl when you do retire. However, they are not accessible until retirement age unless you pay stiff penalties.  But for long term savings for retirement, its hard to beat a ROTH IRA.  There are income limits in that if you make too much you have to use a standard IRA account, not a ROTH IRA.  But that income limit is pretty high. Also, you cannot currently contribute more than 5,000 per year into this type of retirement account.  You can hold any investment within a ROTH IRA account, such as money market funds or short term bond funds.

I hope that this helps. Please do not hesitate to follow up with me if I can be of any additional service.

Sincerely,
Paul Henneman
President
ValuEngine Inc
www.valuEngine.com

---------- FOLLOW-UP ----------

QUESTION: Dear Paul:

Thanks a lot for chipping in, it's good to know you think that what I plan to do is fine.  I am basing these on a couple of "... For Dummies" books I have been reading lately.

Yes, I do have a  Roth IRA, with costly (high up-front load & ongoing operating expenses) funds (which an agent signed me up for a long time ago).  I want to reshuffle those soon as well.

I do have a question: For the Roth IRA, does it make sense to sell the (high expense) funds and buy new (index) funds even if the funds I have have lost some value?  Or should I wait for them to recoup some of their losses before selling them?  Again, thanks very much.

Answer
Thank you for the follow up question!

First, realize that your ROTH IRA can be held anywhere, including online discount brokerage services that charge low fees.
Second, I suggest thinking of your investments always going forward, not back.  This means to think in terms of how can my money best work for me going forward?  Many make the mistake of holding on to under performing investments, looking for a recovery.  It is something about human nature, not wanting to exit an investment that has lost money. But this is a mistake.  Every day is a new day, and if those investments have not performed will in the past, it is likely the won't in the future either. And if they have high expenses, that also won't change going forward.

The other side of this is you don't simply want to jump into something else blind, but need to do some research and have a focused plan on what to do with the funds if you exit those high fee funds.  It is terrible the way agents push funds with high fees, it is for their own advantage as they get large commissions for selling those investments.  Be very, very careful on who you trust in the world of finance!
Index funds are always a decent option to get exposure to the stock markets.  ETF's (exchange traded funds) have very low fees, and you can buy or sell them just like a stock.  There are ETF's that track all sorts of industries, and even foreign markets if you have any interest in diversifying beyond the major indexes. But major index ETF's (such as those that track the S&P500) are certainly a good place to start.

Due to the long term tax advantages when you retire, it would be a positive thing for your financial future to take a close look at your ROTH IRA.  You can move it to a different trading service if needed, can certainly sell your current funds and enter different investments (ETF's, mutual funds, stocks, bonds, money market, cd's are all possible in a ROTH IRA) and should consider continuing to put more funds in there as you are able.

I hope this helps! Please do not hesitate to follow up with me if I can be of any additional service.

Sincerely,
Paul Henneman
President
ValuEngine Inc
www.ValuEngine.com