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Hamowy has the answers
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October 25, 1996: 9:16 p.m. ET
Financial advisor discusses debt, savings, and investments
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NEW YORK (CNNfn) - This week, Charlie Hamowy, a senior financial advisor for American Express Financial Advisors, responded to some of the questions and hypothetical situations you submitted for his expert opinion.
Q: I am now able to exercise some of my stock options. What factors should I consider as I decide whether to sell them all, sell part and keep part, or hold them? They have risen in value from about $50.00 to over $90.00 a share, and I have a large number of share options.
A: Employee stock options present a great opportunity to build wealth and provide a way to leverage your equity, but it's much more risky than owning the stock outright. If the stock price is rising you'll stand a better chance of making more money by keeping your options, but if the stock goes down, you will lose money very quickly. Make sure you are properly diversified.
Don't allow more than 25% of your wealth to be tied up in your company. If it is, exercise your options now. Stock options do have an expiration date, so don't wait too long. Finally, many stock options are lost upon termination. It would be a shame to lose both your job and your gains!
Q: Is paying off credit card debt with a loan better than paying the card and its interest rates? What are the advantages/disadvantages to either plan?
A: Credit card debt is the cancer of personal finance. It's simple: If you can borrow cheaper than credit card rates, then do it! Even smarter, would be to use tax-deductible debt such as a home equity loan to pay off your credit cards. Finally, consider borrowing from a 401(k) plan. This is not optimal for many reasons, but it could be one of your best alternatives.
Remember, try not to use any credit cards that have an old balance. You may be paying it off over the next 18 years!
Q: Up until now, I have not been able to save, but things might be changing. I just came out of bankruptcy in June, and want to start putting money away for retirement. I am now 54. What would be the fastest way to have dollars grow, while not taking a huge risk?
A: The best way to start a savings program is to have it automatically deducted from your checking account or, preferably, from your paycheck. Rule of thumb is to spend 2 1/2 times your rent or mortgage and save the rest. I believe we generally spend 10% more than we need just because the money is there. Solve this problem by redirecting your money into separate accounts.
You should earmark your accounts for specific purposes. For instance, certain accounts are for short-term goals and others are for longer-term goals (i.e.: retirement). Over the long haul, stocks have out-performed bonds.
The best way to have dollars grow is to use a diversified stock portfolio for any goals that are over 4 years. Returns from investments are generally 2% to 3% better, and in the future could mean you'll have double the money. By the way, risk generally does not mean losing all your money. Risk is fluctuation, and you need to be able to live with it.
Q: Many experts agree that one factor in the strength of equity markets in recent years has been the millions of baby boomers who have been pouring money into retirement accounts.
If this is the case, won't the trend reverse as they start to reach retirement age in another decade or two? What's the best way to protect my hard-earned nest egg from the impact of a market battered by millions of boomers moving their money OUT of growth stocks and into bonds or low-growth income-oriented equities?
A: You bring up an excellent point. Much of the market today is responding to the unprecedented influx of equity investing by the baby boomers.
However, the market values today are supported by fairly reasonable earnings levels, and these underlying values are fundamental to the movement of the market over the long term. Eventually, retiring baby boomers will need the money and they will start to cash out. However, they will be spending money and theoretically contributing to additional corporate profits.
Quite frankly, I do not see deflation of the stock market as a result. It would, however, create a huge increase in money supply and eventual inflationary pressure leading to a dramatic rise in interest rates.
All the more reason to have a diversified portfolio constructed in accordance with industry standard asset allocation models. Get thee to a certified financial planner.
Q: I have recently changed jobs and will have my 401(k) and ESOP rolled into an IRA. I cannot join my new employer's 401(k) plan until January 1998. Therefore, I will not be able do any tax-deferred savings in 1997.
Even if I rolled my current 401(k) and ESOP into my new employer's plan, I still can't contribute to it until 1998. Is there anything I can do on my own for next year? I am married and our combined annual income is approximately $80,000.
A: Fret not. The main benefit of 401(k) and IRA savings is not having to pay income taxes on the growth until much, much later. Plus, it's great to get the current tax deduction too!
You can't always get what you want, but get what you need. Consider a tax-deferred variable annuity. The deferred annuity provides the same tax protection as other retirement accounts, but it is funded with "after tax" dollars. In other words, you don't get a current deduction. With a "variable" annuity, you have investment choices similar to your 401(k). Keep in mind, however, that the same restrictions on early withdrawals prior to 59 1/2 apply to annuities the same as they apply to IRA's.
Q: I am fairly new to the world of investing. I profited from the technology boom last year, but also got caught in the downturn. I was not aware of hedging strategies such as options. How can I learn more about options? Any word of advice for novice stock traders such as myself?
A: Option trading can be as close to gambling for a novice as you can get. (Can you say, derivatives?). Many sophisticated investors get burned in the option world every day, so don't lament over your lack of involvement so far.
Options trade mainly on the Chicago Options Exchange. Your broker is required to provide you with a booklet called Characteristics and Risks of Standardized Options that describes the risks of trading options. You must also sign a special disclosure statement stating that you are aware of the risk. This is a good place to start.
The thing that makes option trading even more difficult is that you are betting on the movement of a company's stock price and on when it will happen. Options carry a variety of expiration dates. My best advice for a novice stock trader is simple: don't play with money you can't afford to lose.
Financial goals such as buying a house, financing college, retirement, etc. would preferably be funded through mutual funds. Once your base is established, you can think about gambling.
Q: Would you please explain -- in a simplified form -- the new IRA spousal provisions for contributions starting in l997? Because of excess income (over the limit) on my wife's part, I have not been able to contribute to my IRA, and am wondering if, with this new law, my wife can contribute to my IRA, and who gets the deduction?
A: Under the old law, a non-working spouse is allowed a maximum IRA contribution of $250. This may or may not be tax-deductible, depending on income (there is no deduction for income levels over $50,000) and whether either spouse is covered by a retirement plan at work.
Beginning in 1997, the $250 limit is increased to $2,000, the same level as that for a working spouse. Deductibility rules still apply. In effect, the new law does nothing to change deductibility of IRA contributions. You can still make non-deductible IRA contributions up to the above limits, and these contributions will still grow tax-free but may not be deductible. Also, you need to file IRS form 8606 for non-deductible IRA's.
Observation: If you want to put away non-deductible dollars for retirement, consider a tax-deferred variable annuity, because there is no contribution limit.
Q: How much savings is 'enough' to retire? My wife and I are currently 50, aiming to retire at 55. Current IRA's and 401(k)'s total approximately $1 million, with contributions continuing at 16% of 60K salary. I anticipate a pension of approximately 24K annually upon retirement.
Every financial advisor says "Save as much as you can". Are we at a point where we should be able to retire as planned and continue or enhance our lifestyle? We are in reasonably good health, and health insurance is part of the pension package.
A: The answer to your question depends on how much it cost for you to live.
If it cost you approximately $40,000 per year to live, you appear to be on track to retire at 55. My concerns revolve around your estimate for inflation, longevity and income taxation on withdrawals. There is no way of knowing for certain without a retirement projection.
Be careful about planning for ages 55 to 59 1/2, since there are withdrawal restrictions from IRA's and 401(k)'s during that period.
You don't need to guess, neither do your "financial advisors." There is excellent financial planning software that will tell you exactly where you need to be and how much you need to put away to get there. You can try it yourself, but considering the extent of your assets, I strongly suggest you think about working with a professional.
Q: My mother has inherited over $1 million from her parents, who passed away recently. She is in her late 50's and is still working. Half her inherited portfolio is divided among three stocks: FCOM (over 15,000 shares), MO, and XON.
I am currently keeping track of her money, and I know we need to set up a trust to assure my brother and I receive her remaining assets. She is planning on working full-time at least 5 more years and then wants to work part-time with dividends making up for the difference.
Please give my any suggestions for her estate and diversification planning. Her risk tolerance is greater than it should be for her age.
A: Where do I begin?
Investment strategy. Upon inheritance, the beneficiary suddenly has an opportunity to sell inherited securities without paying any capital gains taxes. You may want to immediately diversify the portfolio. There is just too much risk in having half your money in three stocks. Your new and improved investment strategy should be sensitive to income taxes since your mother shouldn't have to pay taxes on money she doesn't need to spend now. I suggest you create 3 portfolios: short term; intermediate term; and long term, with cash, bond and stocks emphasis on each accordingly. Get an asset allocation prepared for you.
Estate planning is now a must. You and your brother could ultimately lose 30% to 50% of your mom's estate if she should die. Hopefully, she'll live long and be healthy, and the nest egg will grow and grow. It may not be smart to put money into a trust today since she may need the money. However, over time, your estate planning should consider transfers out of her estate to lower the eventual tax.
I am assuming your mother is single. If so, then you may wish to consider a life insurance policy owned by a trust that would be used to replace the estate taxes upon her death. This way, she can gift the premiums to you through the trust, and retain control of the rest of her assets today.
You definitely need to consult an estate planning attorney. Good luck!
Q: I am a single 26-year-old computer professional earning about 50K annually. My question is, what percentage of my earnings should go towards savings, car, housing... What kind of investments best suits my professional and age profile? Thanks for your advice.
A: My general rule of thumb is that housing should equal approximately 40% of your take home pay. Try to save at least 10% of your check now; however by the time you're 30, you should be putting away the maximum in your company's 401(k) plan.
The remaining 50% of your take-home pay should let you live well. Investment strategies depend on the time frame you're investing over. Don't consider stocks for less than a 4-year time frame; try bonds for a 3 to 4 year time frame, or cash and CD's for a time frame of 2 years. Mutual funds are the way to go, especially at your age.
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