Aversion to risk can limit long-term earning power

Dear Bruce: I have $150,000 in my savings. I know I need to move it, but I don’t know what to do. I have a 403(b) at work and have lost quite a bit of my initial investment. I am reluctant to put it into stocks and bonds, etc. Right now, I am earning a disgusting 0.5 percent interest on my savings. Certificates of deposit are not a good option because their interest rates would only yield a penalty at tax time. I would like something safe that earns better interest and doesn’t tie up my money. I’ve spent too many years being poor, so I don’t want my funds to be unavailable should something untoward happen.

Any suggestions? My bank is hounding me, but I think that is because they want me to invest my money in their institution. Please help. – J.M., via e-mail

Dear J.M.: You are correct: You are doing just about everything wrong. You said you are earning 0.5 percent interest; in reality, you are losing money because inflation is greater than 0.5 percent, so at the end of the year, you have less buying power than you had at the beginning.

Like a lot of people, you got burned in the marketplace so you don’t want to go there again, and that is a terrible penalty. Anyone who has invested in the market has lost money on occasion, but most usually make money. With the amount in your savings, you could clearly get some decent advice from an honest, skilled stockbroker. You will have to take some risk, and you shouldn’t be looking at the market every day. With all its roller-coaster moves, the market can be a little disconcerting, but you are investing for the longer term. Whether the bank is the place to invest is another matter.

On balance, you should earn something on the average of 10 percent a year in the marketplace. That includes growth, as well as interest, which is about 20 times better than you are doing now. You are asking for something safe that earns high interest and doesn’t tie up your money. Those are tough things to combine. A certain amount of risk is not a big deal; however, if you are totally risk-averse, you are condemned to a very low return on your savings. That’s the reality.

Inheriting an education?

Dear Bruce: I have two daughters, ages 17 and 12. They have just inherited $6,000 each. Where should we put their money and in what type of program? – M.G., via e-mail

Dear M.G.: You have lots of options, but let me assume for the moment these kids will be college-bound. The 17-year-old’s investment, if it’s to be spent immediately on the first year of college, will only be invested for a short period of time. While there are accounts that will give you some tax consideration, the amount of tax on that short investment is not enough to get excited about. You might investigate the Coverdell education savings account.

As for the 12-year-old, I would seriously consider the Coverdell account. All the money it earns is tax-free, assuming it’s spent for education, and you can choose the investment. If you are reasonably aggressive, the 12-year-old’s money could increase very materially. The big thing is to stash the money before it gets nickel-and-dimed.

Second mortgage vs. car loan

Dear Bruce: I am retired, and my husband will retire in the next three years. He has a 401(k) worth $120,000, and I have a 403(b) worth $140,000, mostly in stock. We each have $30,000 in separate Roth individual retirement accounts. We’d like to put off drawing from these funds as long as possible to ensure enough money for retirement.

Our home has increased in value. We now have $230,000 in equity, and the home will be paid off in seven years. We would like to supplement our Social Security and have some available money for an occasional trip and will shortly need a new car. We’ve been told it would be better to refinance the house to fund such purchases and invest the balance safely. The financial adviser pointed out that we could have the money now instead of waiting until we sell. What do you think? – J.F., via e-mail

Dear J.F.: While the idea of refinancing sometimes makes sense, refinancing for an occasional trip, in my opinion, makes no sense. Getting a second mortgage for a car – not a refinance – makes more sense, because you would likely give up a low interest rate, and the interest on a second mortgage would be tax-deductible. You have to figure the cost of the money versus the teaser rates that many of the manufacturers offer. Today, all bets are off. The interest rates are rising, and only the most creditworthy will be allowed to borrow against their houses in the immediate future. Until the dust settles, tread very carefully. You also mention you have $230,000 in home equity; this may have changed dramatically downward, albeit temporarily. Until you sell, you’ve lost nothing.

Don’t tap into retirement early

Dear Bruce: I consider myself fortunate that I have been saving for retirement. I am 56 years old. I have more than $500,000 in individual retirement accounts and tax-deferred annuities. In addition, I have stock I inherited after my parents’ deaths and I have held these shares for many years. At the moment, however, I have a cash-flow problem.

I need money for one child who will be attending college, and also for my daughter who is a single parent raising a child. If I take money from the retirement program, I will have to pay a penalty and also taxes on the IRA money. If I cash in my stock, I will have to pay capital gains. I am penalized no matter what I cash out. Which would be the more economical way for me to go? – P.V. in Arizona

Dear P.V.: The reality is that you will have to pay the capital gains sooner or later on your stocks. Tapping into your retirement prematurely will incur a penalty plus the tax payments, obviously not a good way to go. While I understand your desire to help your child in college, as well as your daughter, I don’t think you should mortgage your own future to accomplish these goals. While you didn’t indicate whether the youngster in college is working and/or getting loans, I recommend both. If you must dig into your savings, the way to go would be to dispose of some of the stock holdings. Leave your retirement funds alone.

Hold on to cheap money

Dear Bruce: My husband and I are just a few years away from paying off the mortgage and home-equity loan that we took out when we did some major renovations in 2004. The mortgage balance is $49,000 at 4.78 percent, and the equity loan is $22,000 at 6.5 percent. The interest we now pay is not enough to itemize on our taxes.

Our house was really our only major deduction. We have no medical issues or expenses and no kids, and our property taxes are fairly low.

We have mutual funds that could pay off the house. Should we pay off our loans, or continue as we are but with no tax benefit? – J.V., via e-mail

Dear J.V.: Congratulations on getting your financial house in order. Without regard to itemizing your taxes, you have about $50,000 under 5 percent – what a wonderful source of cheap money – and the 6.5 percent on the home-equity loan is not bad.

The overwhelming likelihood is if you’ve selected reasonably well, your mutual funds are returning far better than that.

Why would you want to stop that? In my opinion, I would keep those loans outstanding as long as possible and keep your money invested, earning higher interest rates.

As interest rates go up, which I believe they will, and yours are constant, the spread should be even greater.

Life insurance decision takes financial analysis

Dear Bruce: My husband and I are both 55 years old. Should we continue to put money into term-life insurance for which we have been paying for many years? Or should we cancel these policies and invest the monthly payments? – G.W., via e-mail

Dear G.W.: I assume your nest is empty, but that doesn’t necessarily mean the insurance is not useful.

Since I assume you are each other’s beneficiaries, what would your financial situation be if the other passed away? That is what death insurance is for, to create funds to replace those that would otherwise be earned by the deceased. If you feel there is no need for that money upon the death of one or the other, by all means invest the money elsewhere. I suspect if you take a look at your total financial picture, it would be wise to keep the insurance in place.

Bruce Williams is a national radio talk show host and syndicated columnist. He can be reached at bruce@brucewilliams.com.