Wednesday, January 23, 2008

An Article of Interest
6 Money Dilemmas (Part 1 of 3)

As you invest your money, shop for a home or tackle any one of the many financial decisions you have to make over your lifetime, do you sometimes wish you'd paid more attention in math class? Do you find yourself having to "run the numbers" and wondering how? To help, we've taken six common financial quandaries and done the math for you. As you'll see, the solution isn't always black and white, and the "right" answer may depend on things that you can never know for sure, like your tax bracket in 2020 or how your investments will grow.
Emotional considerations may tip the balance. Even if the math favors buying stocks over prepaying your mortgage, say, you may simply sleep better being out of debt. So this guide will walk you through the caveats as well as the calculations. Come up with your best call.
Pay off a credit card or fund your 401(k)? You should do both. If you can't, pay off the plastic first. In an ideal world, you'd wipe out your costly debts and save for retirement. But in the real world, you may not have enough cash to do both at the same time. Of course, you must pay at least the minimum on your credit card every month. So the question is: Do you put the rest of your available cash in your 401(k) or devote it all to your credit card?
By paying off credit-card debt, you get a guaranteed rate of return equal to your interest rate (the average is 14 percent today). But if your employer matches your 401(k) contributions, that's a 50 percent return (assuming the typical 50¢-to-the-dollar match on the first 6 percent of your salary). Hard to beat. Or is it? The 50 percent match is a one-time gift; the 14 percent interest will compound every year. At some point the cost of that interest will overtake 50 percent. So if you have a big credit-card balance, attack that first.
Let’s say you're deciding what to do with $250 a month. With a $5,000 credit-card balance at a 14 percent rate, your minimum payment is $125 a month. Suppose you put the rest in your 401(k). Because you don't pay taxes on that contribution, you can actually invest $174 a month (assuming a 28 percent tax rate). Keep paying $125 a month on your credit-card balance, and you'll need 55 months to wipe it out. But, if you earn 8 percent annual returns and get the standard 50 percent match, you'll amass $17,271 in your 401(k).
If you plow your entire $250 toward the credit card, you'll pay it off in just 23 months. Then you could devote all your spare cash to your 401(k). By the end of the original 55 months, you'd have $18,515 in your plan. The one-at-a-time approach beats splitting your money because 55 months of paying 14 percent interest outweighs the 50 percent match.
If your credit-card debt isn't that big, and you can pay it off in just a couple of years even if you split your cash, go ahead and fund both goals. You'll get the benefit of the 50 percent match. The bottom line: If you have a big credit-card balance, wipe it out before you open a 401(k).
Save in a Roth 401(k) or a regular 401(k)? Wish you could shelter your retirement savings from taxes, but you make too much to contribute to a Roth IRA? With the recent arrival of the Roth 401(k), you may have, or may soon be getting, a second chance at tax-free income. Grab it. With a traditional 401(k) you invest pretax dollars and pay taxes when you withdraw money; with the Roth you pay taxes on what you put in but nothing on your withdrawals. About a quarter of employers have rolled out this option, and a majority of plans will likely offer it by 2009. Unlike a Roth IRA, a Roth 401(k) has no income caps.
Let's say that you contribute the maximum of $15,500 to your 401(k) and you're in the 28 percent tax bracket. Assuming an 8 percent annual return, you'll end up with $72,245 tax-free in 20 years with a Roth. If you go with the traditional 401(k) instead, you'll also end up with $72,245 in 20 years, but you'll pay taxes on the withdrawals. At the same 28 percent tax rate, you'd be left with $52,016 you could actually spend. When you fund the traditional 401(k), however, you shelter $15,500 from taxes. But even if you invest that $4,340 tax savings outside your plan, you'd have to earn well in excess of 8 percent a year to equal your Roth total after taxes.

By: Janice Revell, www.money.cnn.com

Friday, January 4, 2008

Pressure Mounting for Big Rate Cut
An uptick in the unemployment rate has Wall Street calling for the Fed to lower rates by a half-point.
By Paul R. La Monica, CNNMoney.com editor at large
January 4 2008: 12:27 PM EST
NEW YORK (CNNMoney.com) -- With unemployment rising to 5 percent in December and jobs growth coming in well below forecasts, economists said the Federal Reserve may be forced to slash interest rates when it meets later this month in order to stave off a recession.
In another step to combat the slowing economy, the Fed also announced Friday that it was going to lend up to $60 billion more to banks in two auctions later this month and that it would decide by February 1 if it will conduct more auctions. The auctions are part of a plan the Fed announced in December to to try and restore order to the distressed financial markets.
The government reported December employment figures on Friday. Only 18,000 jobs were added to the nation's payrolls while economists were predicting job growth of 70,000. What's more, the unemployment rate was expected to come in at 4.8 percent, up from 4.7 percent in November.
As a result of these gloomy numbers, expectations for a half-point rate cut grew Friday morning. According to futures listed on the Chicago Board of Trade, investors are pricing in a 78 percent chance that the Fed will lower the federal funds rates by 50 basis points, to 3.75 percent, at the conclusion of its two-day meeting on January 30. There are 100 basis points in a full percentage point.
"The jobs numbers make a half point cut plausible," said Keith Hembre, chief economist with First American Funds in Minneapolis. "The unemployment rate has moved up to 5 percent from 4.4 percent last March and we've usually not had an upward movement of that magnitude outside of a recession."
Prior to the jobs report, investors were pricing in a 67 percent chance of a half-point cut as recession fears have grown in recent days. A report released Wednesday indicated that manufacturing activity is softening while oil prices, which hit $100 this week, have raised concerns that consumers may pull back on spending as a result of higher energy prices.
The Fed last cut the federal funds rate, a key overnight bank lending rate that affects rates for credit card debt, home equity lines of credit and auto loans, by a quarter-point to 4.25 percent on Dec. 11.
In the minutes from that meeting, released on Wednesday, the Fed hinted that more "substantial" rate cuts might be needed if the economy continued to show signs of weakness in the face of the credit crunch caused by last year's subprime mortgage meltdown.
John Lynch, chief market analyst for Evergreen Investments in Charlotte said that he thinks the Fed will now lower rates to at least 3.5 percent by mid-year. He said that despite the spike in oil and other commodities such as gold, the Fed would probably be more comfortable with inflation picking up a bit if it meant that the economy did not go into recession.
With the economy showing so many signs of sluggishness, it's going to be tough for the Fed to argue that inflation is the bigger bugaboo.
"There is no debate with the latest round of numbers. Everything points to a significantly slower economy," said Joe Balestrino, fixed income market strategist with Federated Investors in Pittsburgh.
Still, more rate cuts have the potential to lift oil and other commodity prices further since lower rates likely would further weaken the dollar. With that in mind, there are concerns that the Fed may not be as aggressive as Wall Street wants it to be.
"$100 oil is an unusual factor," Hembre said. "While it doesn't completely change inflation expectations it does complicate things a bit."
Nonetheless, investors are also worried that more rate cuts from the Fed may be too late to save the economy from dipping into a recession.
"A 50 point cut might not make that much difference in stopping a free fall if that is happening," said Oscar Gonzalez, economist with John Hancock Financial Services in Boston.
Gonzalez cautions that he thinks it's still too soon to say that the "sky is falling." But he would be worried if the jobs numbers for January are as bad as they were for December.
"If employment continues to weaken, we could be in for a very rough patch of economic news for at least the next few quarters," Gonzalez said.
Despite the weak numbers, economists said they did not think the Fed would hold an emergency meeting before Jan. 30 to talk about cutting rates.
Hembre said that it would take a "calamity" such as much weaker than expected retail sales figures for December or a lot more volatility in the stock and bond markets to justify an intermeeting move.
Stocks did not react well to the jobs news, with the Dow falling more than 140 points, or 1.1 percent in early afternoon trading and the S&P 500 off by about 1.4 percent .The Nasdaq plunged more than 2.3 percent.
Bonds continued to rally, sending the yield on the benchmark 10-Year U.S. Treasury down to 3.85 percent. Bond prices and yields move in opposite directions and lower yields are typical during a sluggish economic environment.
But Gonzalez suggested that a rate cut before Jan. 30 might actually cause stocks and bond yields to fall further since it could be construed as a sign of desperation by the Fed.
"An intermeeting move would be a cause for alarm," he said.
Instead, Gonzalez thinks the Fed is more likely to use creative ways to try to restore confidence in the markets and economy, such as the Term Auction Facility it announced last month in conjunction with central banks in Canada and Europe.
The Fed devised this proposal in order to encourage banks that need cash to ask for money without having to borrow directly from the Fed at the discount rate, which is higher than the federal funds rate.
The central bank has already loaned a combined $40 billion to financial institutions during two auctions last month. There was strong demand for these auctions and in both cases, the rates for the loans were below the discount rate of 4.75 percent.
The Fed said Friday it would hold its next auction, of up to $30 billion, on January 14 and that another auction of up to $30 billion would take place on January 28.
Balestrino is cautiously optimistic that a half-point cut, combined with the Fed's three rate cuts in 2007, could keep the economy from heading into a recession.
He adds that if the economy continues to slow in the next few months, the Fed could lower rates by a half-point at its March 18 meeting, or even at an unscheduled meeting in February.
Fed lends $20 billion to banks in first auctionBernanke's tightrope actFed cuts rates by quarter-point