Parents and the Financial Crisis: An Update

EDITOR’S NOTE: With their retirement savings crushed by the 2008 market crash, millions of older adults are turning to their children for help. SmartMoney Senior Editor Beverly Goodman is one of those children, and she recently embarked on a special report, “Parents in Crisis” (read the full report here). Below, she continues to chronicle her experiences and thoughts as she helps her own mother address her finances.

February 10, 2009

Like everyone else, I’ve been thinking a lot recently about where I can save money. I’m buying household items in bulk more than I used to, for instance. (I’m only a little embarrassed to admit there’s a 12-pack of toilet paper on a shelf in my bathroom.) But I’ve also been careful not to buy more than I need. There are tons of hidden costs embedded in any shopping trip, and any smart shopper knows what to be wary of.

Even wary shoppers, however, often lose those instincts when the products they’re buying are investment vehicles. That’s in large part how my mom ended up in so many high-cost funds that came with all manner of sales charges: Her broker sold her the funds that made him money, rather than the best out there.

Her new financial planner, Gary Schatsky, got her out of all those funds and put her in low-cost funds that were more appropriate investments. But he did it with an eye toward saving money in some surprising ways. In the short term, Schatsky was able to save my mom more than $600 in transfer fees, termination fees and other fees from her old “wrap account” at Ameriprise (an account that a broker manages for a flat fee, rather than on trading commissions).

TD Ameritrade reimbursed my mother for all this thanks to Schatsky’s relationship with that firm: It’s one of his two “platforms,” the brokerages he uses to make all of his clients’ trades. That’s a good reminder for anyone looking for a financial planner — ask what sort of relationships he or she has with the brokerage platform (TD Ameritrade, Charles Schwab or Fidelity, for instance). If they’re able to get you deals such as waived or lowered fees or access to cheaper, institutional mutual fund shares, that could save you almost as much as you’re paying the adviser in fees.

January 30, 2008

My mom has always—and I mean always—taught me the importance of saving. You saved for the ill-defined, off-in-the-distance “rainy day” and you saved for anything (you thought) you just had to have now. (Endless hours of babysitting and an after-school job at the public library paid for a new violin and my first contact lenses.) When I graduated college my mom impressed upon me the importance of saving through a 401(k). Even though those accounts were relatively new, my mother immediately understood the importance of the tax breaks that came with them.

That’s why mom and I were both so surprised when her new planner filled us in on his tax strategy: stick her stock funds in taxable accounts instead of tax-deferred ones.

There are two schools of thought on this investing and tax strategy. The one my mom was following dictates that stock mutual funds should be held in tax-advantaged accounts like IRAs and 401(k)s because they tend to throw off short-term gains—a result of the fund manager’s buying and selling—that are taxable at your income tax rate. (And yes, you pay those taxes even if you don’t sell any fund shares—unless they’re in a tax-deferred account like a 401(k).) But our planner, Gary Schatsky, wanted to take just the opposite approach. He wanted my mom to move her 401(k) entirely into Pimco Total Return—a bond fund. Her equity holdings, Schatsky explained, were better off in taxable accounts.

Here’s Schatsky’s logic: By owning stock funds in a taxable account, mom could take advantage of lower capital gains rate when buying and selling fund shares. Sure, she might owe a bit in taxes she wouldn’t otherwise, though the funds Schatsky chose don’t trade frequently and therefore don’t generate much in the way of annual capital gains. They should, however, appreciate much more than her bond allocation, and in the long term (once she’s retired) she’ll be able to sell all or part of those stock funds and pay the relatively low capital gains rate, whereas all withdrawals from her IRA will be taxed at the higher income tax rate. Plus, if something goes wrong with one of the funds and it needs to be dumped, my mom will be able to claim a loss—a deduction not available if the loss is incurred in an IRA or 401(k). Complicated stuff, but a seemingly sound strategy.

January 26, 2008

Like so much in life, big change is often only evident after a slew of annoying little steps, detours and delays. While it didn’t take long for my mom’s new financial planner, Gary Schatsky, to open a TD Ameritrade account and migrate all of her assets, there was some work to be done before actually investing her money properly.

For starters, my mother owned several B and C class shares of mutual funds—which meant there could be big fees levied on their sale. Brokers are paid by the fund company through these fees, or loads: Generally speaking, Class A shares come with an upfront sales charge but have the lowest annual fees. Class B shares incur a sales charge if they’re sold within a certain period of time, usually six or seven years—but carry a higher annual fee. Class C shares may have a small sales charge upon sale (or none at all), but you pay a high fee throughout, making them a very bad deal for long-term investors.

Schatsky’s first goal was to see what, if any, fees my mother would incur upon selling. Turns out, she had owned all her funds long enough that the answer was: None at all. So once he had the go-ahead from my mom (which took at least a week to achieve), Schatsky set about liquidating virtually all her holdings, and reinvesting them into no-load funds from Vanguard, Ivy and Artio (formerly known as Julius Baer). All in all, it took about six weeks to accomplish this.

Even in the best of times, high fees eat away at returns. In volatile markets such as we’re seeing now, keeping costs down is of utmost importance. While some of Schatsky’s choices were fairly conservative (the Vanguard fund he picked was its classic S&P 500), he’s apparently a believer in active management, and chose a few funds known for good stock-picking in their niches (Ivy for its Global Natural Resources fund and Artio’s international fund). How will this work out? Let the tracking begin.