The Behavior Gap

Image courtesy of Carl Richards, BehaviorGap.com

As a financial journalist, one of my goals has always been to take confusing, tricky, overwhelming information and explain it in simple language that even my friends can understand!

No one does this better than Carl Richards, a Certified Financial Planner in Park City, Utah who's famous for his Sharpie drawings (like the one above). They illustrate what he’s coined as "the behavior gap"—the distance between what we should do with our money and what we actually do, thanks to our emotions.



So, naturally, I was psyched when Carl told me he was writing a book, aptly titled The Behavior Gap, which came out this week.

In the book, Carl explains how you might be sabotaging your finances without even knowing it. Some of the hidden dangers to your investments, for example, include falling prey to media overload, taking stock advice from unreliable sources (say, your pushy brother-in-law), and panicking every time the Dow dips. His major point is that once you ignore all that chaos, it's easy to see that financial planning is really about life planning. What do you need to be happy, and how can your money get you there? (Good questions to ponder as you plan for 2012!)

Carl regales readers with lessons from his own financial curveballs, and the mistakes of his clients, who sometimes cave to their emotions despite his best efforts to guide them. And, of course, the best parts of the book are Carl's famous sketches, which you may have seen before on The New York Times' Bucks blog and on Carl’s website, BehaviorGap.com. Here's another one of my favorites, illustrating how awkward and uncomfortable money conversations can be:

Image courtesy of Carl Richards, BehaviorGap.com 

Have you ever fallen into a ‘behavior gap,’ when emotions got in the way of smart money decisions? Share your stories.

Warren Buffet Invests Like a Girl—And Why You Should, Too

I was excited when my friends over at The Motley Fool told me about their new book, Warren Buffet Invests Like a Girl: And Why You Should, Too. 

The title alone is intriguing, but so is the premise: Women have innate qualities that make them better investors than men. Author LouAnn Lofton points to eight traits common to women (and to Mr. Buffet), including their patience (they trade less often, so they save on fees and benefit from long-term growth), their lack of overconfidence (they admit what they don't know and ask questions), and their diligence (they research before investing so they buy stocks they understand).

So many women still (falsely!) assume that men were born with money skills. Thankfully, this book turns that theory on its head. Women who pick it up will get an immediate confidence boost once they realize that they were the ones blessed with the investing genes.

Plus, the book is practically a how-to investment guide, full of tips based on Buffet's life story, investment philosophy, and all-around wisdom. (In Yiddish, we'd call him a mensch—a downright honorable guy!) Even if you've never invested before, you'll learn the basics of how to pick and choose stocks. And who better to learn from than the legend himself?

But remember, investing in stocks is risky business, and you should consider it only if you've already invested in your 401(k) or IRA, built an emergency fund, and don't have any upcoming big expenses that would require the invested money.

Pick up a copy of the book and let me know what you think.



Newsflash: Brokers Soon Obligated to Put Clients' Interests First

It may sound like a joke headline in The Onion, but right now, if you hire a broker to handle your investments, he or she isn't required to put your interests before his or her own. The good news is that seems poised to change.

Last Saturday, the SEC released a study recommending that brokers abide by the same golden rule as investment advisors: Put the client's interests first. (Last year's financial reform law kick-started this initiative.) It's unknown yet whether the SEC will be able to turn their suggestions into action, but until then, here are a few things to keep in mind:

1. Brokers aren't clairvoyant. There's no evidence that advice from these would-be experts justifies the steep commissions they charge. And all brokers—who are salespeople, not stock analysts—generally make money by getting you to buy or sell stocks.

2. You can invest without a broker. Brokerage firms tend to sell funds with loads (commissions) and substantial fees, and their minimum investment requirements are usually high. Even if you go with a discount broker, there's often some kind of fee involved. Instead, purchase investments through a low-cost mutual fund company.

3. If you feel compelled to use a broker, wait until this gets sorted out. I'll keep you posted as I find out the latest news.  

4. And then, stick with a discount broker. A typical transaction that would cost you on average $10 at a discount broker could cost $50 at a full-service firm. Also, full-service firms often charge annual maintenance fees of about $150 a year. Every year, SmartMoney ranks the best discount brokers—read it before you decide.

And heads up: We can expect to see more debate over the role that the SEC and other regulatory agencies should play in consumer issues like this, especially in the run-up to the Consumer Financial Protection Bureau's launch in July and beyond.

Do you use a broker? Would you consider hiring one if this issue is resolved? 



The Retirement Priority Box

As you consider your goals for the New Year, I hope one of them is to save for retirement. But with so many different ways to go about it, you may be left with one question: What do I do first?

Here's a suggested list, in order of priority. Even if you can tackle only the first or second step below, that's a great start. If you can go further, even better!

1. Contribute to a 401(k) with employer matching. Many companies reduced or suspended matching mid-recession, but if you're lucky enough to work where this is offered, it's the best deal around and, therefore, your number one priority. The match alone can generate an immediate 50% to 100% return on your money (once you're vested), and either flavor of 401(k)—regular or Roth—provides years of tax-advantaged growth. Don't put money in any other retirement account until you have reached the limit of what your employer is willing to match.

2. Open an IRA (Roth or fully deductible). If you've reached the match level on your 401(k) or your employer doesn't offer matching, consider one of these two options. Your eligibility depends on your income level, whether you (and your spouse) have a retirement plan through work, and other factors. A Roth IRA offers completely tax-free growth forever, but you don't get to deduct your contribution from your income; a fully deductible IRA offers years of tax-deferred growth (you pay taxes when you withdraw), but you can deduct your contribution from your income. IRAs also allow you to withdraw money penalty-free to buy your first home or pay for educational expenses. (Discover the best way to open an IRA.)

3. Open a partially deductible or nondeductible IRA. If you have contributed the maximum to your 401(k) that your employer will match and you're not eligible for a Roth or fully deductible IRA, this is your next best choice. The reason: Tax law now allows you to convert any IRA into a Roth IRA. (To see which IRA options you're eligible for, use Smart Money's calculator.)

4. Contribute to a 401(k) without employer matching. If you've already contributed the maximum to options 1 through 3 above, try to max out your 401(k)—even if it's a stretch on your budget.

5. Save beyond a 401(k) or IRA. Once you've exhausted your tax-favored savings options—IR As and 401(k)s—you'll have to save in bank accounts, money funds, and other types of mutual funds in the regular old taxable way. But if you invest well, you'll be thankful down the road. (See my top tips on investing.)

What priority would you like to tackle in the New Year?



What's a Roth 401(k)?

If you know anything about retirement plans, you probably know about the big guys: the 401(k), the traditional IRA, and the Roth IRA. But what about the Roth 401(k)?

Quick review of the more well-known plans: A 401(k) is a tax-deferred retirement plan offered by your employer, meaning money is deducted from your paycheck before taxes, but you pay taxes when you withdraw the money in retirement. An IRA is a retirement account you set up yourself: A traditional IRA offers an up-front tax break by letting you deduct your contribution from your income for that year, while with a Roth IRA you pay taxes before you contribute, but then you'll never be taxed again.

The Roth 401(k)—a combo of the Roth IRA and 401(k)—is the new kid in town. It began in 2006, and only a third of employers offer it, as of the last count. But it could grow in popularity now thanks to a provision in the new Small Business Jobs Act (SBJA) that will soon make it easier for some 401(k) holders to switch to a Roth 401(k).

Why would you want to switch? In a sense, the Roth 401(k) is the best of both worlds: the tax advantages of a Roth IRA and the company support (and, often, matching program) of a 401(k). The amount you can contribute is the same as a 401(k): up to $16,500/year for most participants, with an extra $5,500 for workers 50 and older. However, while money in a regular 401(k) is deducted pre-tax, Roth 401(k) funds are deducted from your after-tax income.

Here's the catch (you knew there'd be one!): If you switch from a pre-tax 401(k) to an after-tax Roth 401(k), you have to pay taxes on the funds you're converting. (Just like when you switch from a traditional IRA to a Roth IRA.) This tax payout may turn off older workers who have a considerable amount built up in their account and can more easily afford to pay taxes in smaller increments, as they withdraw funds post-retirement, than in one huge lump. Generally, paying taxes now through the Roth option is good for workers who expect to end up in a higher tax bracket by retirement, or who are concerned that tax rates will rise in the future.

With the Roth 401(k) provision coming on the heels of the IRS lifting the income limit for folks to roll over a traditional IRA into a Roth IRA, this has been a banner year for expanding retirement account options. However, many of the details of the roll over option are still in flux. Since the SBJA was just passed in late September, employers and the IRS are scrambling to figure out how this provision will actually work in practice, and most employers face a deadline of December 31 to make changes to their 2010 plan offerings. According to a lawyer I spoke with who has written about the new provision, many observers expect the IRS to offer additional guidelines within the next month or so. If you're interested in rolling over to a Roth 401(k), ask a human resources representative about your company's plans.

Would you switch to a Roth 401(k)?