Regular readers of this newsletter know I believe in discipline, and one of the most productive practices I follow every year is listing ways I can make myself a better investor and make my money work harder for me and my family.

I am sure you could benefit from an exercise like this yourself. Everybody’s situation is unique, and I can’t pretend to prescribe all the right moves for you. But I hope you will use the following list of ideas, whether or not they apply to you, to stimulate your own thinking.

If you have cash in a money-market fund, you know you’re not making much money. You can probably do better than you think if you’re willing to do a bit of shopping.

For instance, earlier this year, Vanguard’s Web site showed that its Federal Money Market Fund (VMFXX) had a seven-day average yield after expenses of 0.75 percent. Meanwhile, the Vanguard Tax Exempt Money Market Fund (VMSXX) had a seven-day average yield of 1.02 percent.

(A Vanguard representative attributed about half the difference to a higher expense ratio on the taxable fund. He said the rest stems from the fact that many tax-exempt securities are issued by government agencies that could face fiscal trouble. That lower quality, of course, drives prices down and yields up.)

My point is not to push you into tax-exempt funds but to show you that a bit of shopping around can turn up bargains where you would never expect them.

If you have money in a bank, find the highest interest rate you can. Where I bank, a regular interest-bearing checking account pays a miserly 0.1 percent. That is essentially a joke! But the bank has a Platinum checking account which is open to anyone with a balance of at least $10,000 (or with a mortgage or other loan of at least that much). The interest on Platinum checking is 1.36 percent on balances over $25,000.

That’s still not much, but on a $25,000 balance, it’s the difference between making $25 a year with regular checking or $342.50 with Platinum checking.

This should be money you don’t think you will need any time soon. Try to make this money work harder for you. A short-term bond fund will pay more than a money-market fund without much additional risk.

If you think you probably won’t need this money for four or five years, consider using a fund that owns both stocks and bonds. Vanguard Wellesley Income Fund (VWINX), for example, keeps about 37 percent of its assets in stocks and the rest in bonds and cash. In the five years ended December 31, this fund produced a 6.8 percent annualized return without the volatility of stock funds.

If your IRAs are scattered in accounts at banks, credit unions, mutual funds and brokerage houses, you are probably paying multiple annual fees in the $10 to $20 range. Whether you pay them in cash (some custodians give investors that option) or the money is taken out of your account, those fees nibble away at your retirement.

Most investors don’t need multiple IRA custodians. By consolidating, you may be able to have one or two accounts, each of which is large enough to avoid this fee.

In addition, you’ll find it easier to keep track of your investments in fewer accounts.

The way you allocate your assets is the most important investment decision you will make. Your investment plan should specify your percentage allocations between fixed-income and equity investments. Within the equity part of the portfolio, you should have target allocations for U.S. and international funds as well as for big-company stock funds and small-company stock funds. Your plan should also specify how much is to be in value stocks and how much in growth stocks.

If you have a financial advisor, set up a meeting to evaluate your current allocation. The advisor can suggest any necessary changes. If you don’t have an advisor, use a very handy tool available online at www.Morningstar.com. This is called the Instant X-Ray. Just enter the information for your stocks, mutual funds and cash into this form, then click on “Show Instant X-Ray.”

You’ll find out how your holdings stand up in terms of Morningstar’s style boxes. You’ll see how much of your account is in cash, how much in fixed income and how much in equities. If you own several mutual funds that own the same stocks, this tool will instantly add up all those holdings and calculate the stock-by-stock totals as a percentage of your whole portfolio.

After a year like 2003, when equities seemed to go through the roof, your investments may have taken you some distance from the proper allocation you determined for yourself. If you began 2003 with a portfolio equally split between stock funds and bond funds, you might have begun 2004 with about 60 percent of your total in equities and only 40 percent in fixed-income funds.

What’s wrong with that? Too much risk. A portfolio with 60 percent in equities is riskier than a 50-50 portfolio. Rebalancing gets you back on track. And there’s another benefit: By rebalancing you will be taking some of last year’s profits “off the table” and spreading them around.

This is called buying low and selling high. Rebalancing makes it automatic.

You’ve seen this advice here many times. Maybe you think you’re already properly diversified. But the vast majority of portfolios I’ve seen are not that well put together.

Most portfolios are heavily overweighted in large-cap U.S. growth stocks. That may seem fine in a year like the one we just experienced. But diversification pays off in good times and bad. It’s a rare investor whose equity portfolio couldn’t be improved by adding one or more of three kinds of funds: value, small-cap and international.

If your employer has a 401(k) or similar plan, your first priority should be to contribute as much as it takes to qualify for any matching funds available to you. If you don’t do that, you could be essentially throwing away free money.

Your second priority should be to contribute as much as possible to your Roth IRA. This is the best tax shelter most people will ever have. Roth IRA contributions can be made only with after-tax dollars, so you won’t get a tax deduction for putting money into such an account. But you’ll get something much more valuable: tax-free investment earnings.

After you max out your 401(k) contributions that are eligible for matching money and you fully fund your Roth IRA (the limit is $3,000 for most people this year), your choice is whether to add more (if you are eligible) to your 401(k) plan or to invest in taxable accounts.

This is a tricky decision, for tax reasons. Most 401(k) contributions are tax deductible, making them less onerous. But everything that’s eventually withdrawn from such a plan will be taxable as ordinary income. That means stock dividends and capital gains you earn in a 401(k) plan won’t be eligible for the 15 percent maximum rate for long-term capital gains in a taxable account.

If you’re facing this dilemma, your action item should be to consult with a certified public accountant (CPA) or other tax professional to evaluate your individual situation.

Make a written investment policy statement for yourself. In my experience, the rare investors who actually do this are far more likely to attain their goals than those who just casually think about it.

Writing a policy statement requires careful thought, but once it’s done it will remind you rationally, when the market is trying to manipulate your emotions, what you should be doing and why.

Write down your long-term financial goals and make a written retirement plan. That plan should specify a target year you want to retire and estimate how much retirement income you will need from your investments. From there, you’ll be able to tell how big your portfolio will have to be when you retire. For a quick rule of thumb, figure that on the day you retire, your portfolio should be 20 times the size of the annual income you want from that portfolio.

If this is starting to sound like serious work, then you’re getting the point. There’s no free lunch for somebody who would be a successful investor. But the payoffs from this step could be enormous. You could retire earlier or boost your retirement fund by hundreds of thousands of dollars.

At the very least, all this written work will give you a clear picture of where you stand so you don’t need to rely on vague hopes or fears.

Make a written pre-retirement plan showing how you will accumulate the nest egg you will need on your retirement day. An excellent place to start thinking about this is to read or review some of the retirement-related articles on our Web site, www.FundAdvice.com.

I particularly recommend “The Ultimate Buy and Hold Strategy” and “Fine Tuning Your Asset Allocation.” If you are already retired, read or review two other articles: “Retirees: Lower Returns = More Money” and “Retirement: When Your Portfolio Starts Paying You.”

The investment industry is skillfully organized to nibble away at your retirement savings in many ways. It’s up to you to keep the lid on your costs.

When you invest in bond funds, remember that the single greatest factor that separates the top performing funds from the laggards is the expense ratio. You’ll probably find the lowest bond-fund expenses at Vanguard.

When you invest in equity funds, remember that every extra fraction of a percentage point of annual expenses means one of two things: A. Your fund manager has to take higher risks in hope of achieving enough extra return to overcome the higher expenses; or B. You are giving away some of the return that your portfolio earned for you.

Take a break and go through your closet. Everything you haven’t worn for the past 24 months goes into a pile. Unless there’s a compelling reason to keep it (and that decision should be confirmed by a spouse or a friend), every item in that pile goes to a charity.

You’ll wind up with a more workable closet. You’ll get a tax deduction. And you might even dress a little better this year.

Finally, keep looking for more things you can do in 2004 to strengthen your financial muscles. A year from now, you will be glad you did.

If you’d like to share some of your best financial moves, send them to me by email ( ). We will use your ideas to inspire future articles.

 

 

Discover how professional money management can help you.  Get a Free Consultation from a Merriman financial advisor.