Jump to content
Sign in to follow this  
pab

Where To Put Extra $?

Recommended Posts

I am a public school teacher who has $50k spare "change" to invest. Our school district has 403b and 457 deductions available. I have not maxed out my dedutions in either. I am over 60 and will not need the money for at least 5 years. I am 1 year away from retirement. I have low risk tolerance for loss.

Help!! Thanks.

Share this post


Link to post
Share on other sites

Pab:

 

I would advise you to max out on both plans asap. Based on your aversion to loss I would invest in a AA/AAA bond fund. Use no-load mutual funds. Do not invest in a Variable Annuity unless you have intention to annuitize. If you have TIAA at your disposal you could use their Traditional Fixed Annuity contract because it is no-load.

 

After making these maximum contributions to your 403(b)/457(b) you may very well come up short with your take-home-pay. Any deficiency can be made up by withdrawals from your 50K spare "change" which should be kept in a AAA bond fund like the Vanguard GNMA fund with a check writing feature.

 

Peace,

Joel L. Frank

Share this post


Link to post
Share on other sites

Pab,

 

For anyone to give you any useful advice we would need to know the following-

 

1) What other assets do you have?

2) How much income will you be looking for in 5 years from these assets?

3) For how long will you need this income?

4) Are you married?

5) What other retirement income will you have?

 

Bill Mahoney

Share this post


Link to post
Share on other sites

Joel,

 

Were you around in the late 80's? If you were you should remember the catastrophe of GNMA funds. In a rising interest rate environment, GNMA funds will experience substantial losses of principal. Mortgage backed securities are horrible investments in a rising rate environment.

 

I also agree with Bill that you do not have nearly enough information to make a recommendation.

 

Mark Fischer, CFA

Share this post


Link to post
Share on other sites

Bill and Mark:

 

Mark, Interest rate risk of buying bonds/holding bonds in a rising interest rate market is surely present. Do you remember the 1970s? One always must monitor the trend of interest rates AFTER they buy a bond or a bond fund otherwise they coud get stung badly. The opposite has been true over the last handful of years where GNMA funds have generated very handsome profits. Mark, do you advise someone who invested in a GNMA three years ago to get out now in anticipation of rising rates over the next three years or so?

 

Bill, your points are very well taken. Let's see if Pab gets back to us so that we can really roll up our sleeves and advise. But as you know many people are not comfortable with furnishing the needed information on a public chat room like this. I share your frustration.

 

Peace,

Joel

Share this post


Link to post
Share on other sites

Joel,

 

Price volatiltiy of fixed income investments are measured by the duration of the investment. The higher the duration, the more volatile the investment. So in falling rate environments, high duration investments have the largest increase in value, and in rising interest rate environments, they lose the most money.

 

Due to mortgage prepayments which increase in a falling rate scenario and decrease in a rising rate scenario, mortgage backed securities, including GNMAs, the duration of MBS are counterproductive. Here is what hapens:

 

1. When rates fall, mortgage prepayments increase and thus the duration of the MBS decreases. Remember, we want high durations when rates are falling.

 

2. When rates rise, mortgage prepayments decrease and thus the duration of the MBS increases. Remember when rates are rising, we want low duration fixed income investments.

 

MBS are good in relatively stable rate environments, or in some case to match liabilities of an investor.

 

For an investor who has a "low risk tolerance for loss," GNMAs are not appropriate especially for short term money.

 

To answer your other questions, yes I would advise someone to sell their GNMAs, if they believe rates are going up, unless they are part of a portfolio strategy implementation. This is a general comment, and not a recommendation for any specific investor.

 

A couple caveats, first as an experienced bond investor, I find it very difficult to monitor interest rate trends and base trades on you observations. The word whipsaw comes to mind. Second, the last few years do not represent a full picture of fixed income performance history.

 

For those of you who are not aware of what happened in the late 80's, I will provide a recap. After the market crash in 87, many reps and brokers started peddling GNMA funds. They did so for two main reasons, income the ease of the sale. Older investors were especially solicited.

 

GNMA funds had fairly attractive rates of income, due to the rates of the undrelying mortgages. Investors were scared to death by the crash and did not want to buy equities. GNMAs are guaranteed by the US government, although technically the bond fund is not. Thus, many older investors bought the sales pitch.

 

As it happened, rates started to increase. As they went up, investors experienced losses in their funds. Many of these investors could not afford the volatility.

 

Many reps do not understand the products they sell. They sell based on the pitch of the month and what is easy.

 

I find it interesting that withing the past few month the NASD issued a Notice to Members, reminding firms of the volatility of bonds, and its obligations to take it into consideration when determining the suitability for its clients.

 

Mark Fischer, CFA

Share this post


Link to post
Share on other sites

Joel,

 

I agree with you that the vast majority of people do not feel comfortable sharing this type of information in a public chat room. Which is why I generally efrain from giving specific advice like this.

 

Bill Mahoney

Share this post


Link to post
Share on other sites

Mark,

 

I know timing of equity trends is difficult but there are some (not many) that are correct with their signal about 80 percent of the time. What is the relative difficulty of timing interest rate trends? Are there not simple indicators available?

 

Joel

Share this post


Link to post
Share on other sites

Joel,

 

Not that I know of. I personally try to take a longer term view when making weighting decisions. I look at real interest rates and make a forecast of inflation. My inflation forecast is based on a number of economic indicators and a certain gut feeling, since economic indicators tend to be inaccurate.

 

That being said, the market also moves in the short to intermediate term based on its aggregate feeling for the FEDs position. I have never understood the logic in this, since the FED actions the vast majority of the time effect the short end of the curve. Theoritaclly if the FED increase short term rate, long term rates should fall, since the higher short term rates should lower future inflation. However, most of the time the opposite effect occurs.

 

Anyways in my opinion, timing either the bond market or stock market should be left to those who understand the nuances and have the time to dedicate to trading. Most 403(b) participants do not.

 

Mark

Share this post


Link to post
Share on other sites

Mark,

 

Thanks for you information about bonds. As I head for retirement in a few years, I need to learn more about them. I agree with you about timing either bonds or stocks and that most people in 403b should not, but I don't agree with you that just because somebody has financial credentials, experience, resources and time that they can make successful trades consistently over time. Bogle and others have written books on the fallacy of timing the market.

 

I am considering DCA into TIPS because of the massive tax cuts, low interest rates (for now) and looming fed budget deficits for years to come is going to end up in inflation. What do you think?

 

Thanks,

Steve

 

Share this post


Link to post
Share on other sites

Steve,

 

There are 2 ways to approach this. The first would be to create a laddered bond portfolio. What I mean by this is you purchase bonds in various maturity lengths. You put 20% of the money into 2 year, 3year, 5 year, 10 year, and 20 year bonds. This way you are protected if interest rates either rise or fall. If the rates rise you have the shorter term bonds which when the mature you can reinvest into higher yeilding bonds. If rates fall you have the security of the longer term bonds paying you a higher interest rate.

 

The second way of protecting the income , as well as the principal, is to purchase an annuity. This way if rates increase, so will the interest rate that the annuity pays. If rates fall you have a guaranteed floor on which the annuity cannot go below in the rate it pays you.

 

Bill Mahoney

Share this post


Link to post
Share on other sites

The second way of protecting the income , as well as the principal, is to purchase an annuity. This way if rates increase, so will the interest rate that the annuity pays. If rates fall you have a guaranteed floor on which the annuity cannot go below in the rate it pays you.

+++++++++++++++++++++++++++++++++++++++++++++++

Bill: Is the above scenario prior to or after annuitizing?

 

Joel

Share this post


Link to post
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.

Guest
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...
Sign in to follow this  

×
×
  • Create New...