Help! Man Overboard! Help!

Robert O. Weagley, PhD, CFP^®

The seriousness of the economic downturn has hit academia and universities across America are taking steps to reduce their costs, as a way of staying within their budget. Particularly hard hit are those institutions that rely heavily on endowments to provide income for their operations. In December of 2008, Stanford University announced a 10% pay reduction for its top administrators. In a similar vein, the prospects of employee furloughs have surfaced from Maryland to California, including being mentioned this week by the President of the University of Missouri System, Gary Forsee.

I’ve had people ask me what a furlough means. It is essentially a pay cut, for the employee is asked to take time off from work without being paid. On the other hand, it is different from a pay cut, because a furlough is temporary. Moreover, if you don’t have to go to work at, say, the university, you could actually find a temporary job, or self-employment, to enhance your income – while maintaining your benefits at your place of employment.

What should you do, if the prospect of you being thrown overboard as a cost saving measure looms on your horizon? The answer is relatively simple. You need to budget now to prepare yourself for additional cost-saving decisions should they become necessary. In that light, it is very important for you create and maintain an emergency fund to help you through this potential time of reduced pay.

To begin, you must budget your money. Some helpful worksheets and other information are provided on our Office for Financial Success website . You need to know where your money is going, if you are to have any hope of plugging the holes in your bucket, reducing expenses, and succeeding through these tough times.

An important part of this program is to establish an emergency fund. When you hear the word furlough, you have to wonder, “How long can I go without a paycheck”. Most financial professionals recommend you have from three to six months living expenses in your emergency fund.

We know that most families do not have an emergency fund. As a result, they pay more for insurances that have lower deductibles and they face greater stress when it comes to economic uncertainty. Most would agree that these are key areas to establish if you are able to enjoy your financial life. A liquid emergency fund of three to six months living expenses is a real key to financial success.

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Bonds. (We're not talking about baseball.)

Robert O. Weagley, PhD, CFP®

The recent carnage in the stock market has increased interest in bonds as an investment category. While many corporations’ bonds have also been hit hard in the current economic malaise, many writers point out that the difference between the yields on bonds and Treasury bonds has not been this great for half a century. This is even true for municipal bonds, that are generally free from federal and, sometimes, state and local income taxes. Why is this and what should you know?

Municipal bonds have a reputation for safety. Municipal bonds, for example, that are general obligation bonds, have the full taxing authority of the issuing government behind them. So why, then, are municipal bonds packing after-tax yields of 8%. (This is greater than the 7% after-tax yield on stocks since 1926.) The answer, unfortunately, rests in the fact that the municipal bond market is rather fragmented and that most issuers use bond insurers – the same insurers that have been beat-up in the mortgage meltdown.

According to Jason Zweig, of The Wall Street Journal ($$$), another reason is the fact that many municipal bond mutual funds have invested in tender option bonds which take the bonds and create two separate products, the short-term fixed part and the long-term variable part. The long term variable part has examples where upwards of 50% of the value of the bonds has been lost in the past year.

So what’s an investor to do?

First, do not purchase individual mutual bonds, unless you’ve substantial assets to invest. Most municipal bonds have face-values of $5,000. Thus, an investor with $100,000 would purchase 20 different municipal bonds with his/her money. One default or mistake could easily cost you 5% of your principal. On the other hand, investors could purchase municipal bond funds. In fact, investors with state/local income taxes can often find municipal bond funds that only have bonds from their state to take advantage of this additional “no-tax” benefit. (Guess what, New Jersey, New York, and California are high income tax states with the law favoring in-state bonds. Would you like your municipal bond portfolio to be only invested in one of these states at this time? I don’t think so.)

Each time we think about investing in a mutual fund, remember to do some simple things:
· Try to only consider bond mutual funds with annual expense ratios of less than 0.5%, or lower. For stock funds, the threshold can be raised to 1%.
· Read the prospectus. Better yet, download it from the web, and then read it – first with the “find” option on your document editor. Look for key words:
o Tender
o Option
o Bond
o Derivative
o Inverse
o Ratings – see what the prospectus says are the “ratings” of these bonds. Remember BBB, or greater, are investment grade bonds. BB, or lower, are “junk” bonds.
o Make sure you know the expense ratio and that it is within reason (0.5%, or less, for bond funds)
o Turnover ratio should be 50% or less. More than 50% for a bond fund is excessive and adds to the funds internal costs which are passed on to the investor.
· Try to stick with fund families with stalwart reputations; Vanguard, T. Rowe Price, PIMCO, among others.
· Finally, read and study more about personal finance. Seek out programs offered by your local Extension office, on-line courses or informative websites, community college coursework, adult education programs, or your local university.

Yes, there appears to be investment opportunities in today’s market – a market that has slowed many a person’s quest for financial success. Look at these opportunities but do your homework and seek more information. While many people can manage their personal finances without the aid of paid assistance, others need assistance to help wade through the details of today’s investing world. If you’re one of these, pay someone to help you. Success rarely comes to one who sits and waits on her. Success prefers those who pursue her.

- Robert O. Weagley, Ph.D., CFP(r)
Chair, Personal Financial Planning
University of Missouri
Columbia, MO 65211