Because Fidelity administers my solo 401(k) plan, I can buy only what's available through Fidelity. I looked at new-issue brokered CDs. The yields are lower than the best rates available from other banks and credit unions.

Then I looked at secondary CDs. Secondary CDs are like "pre-owned" cars. They are being sold by bond dealers. The dealers bought the CDs from the previous owners, who for one reason or another decided not to hold the CDs to maturity.

The good thing is that these "pre-owned" CDs still carry the same FDIC insurance. The banks are still obligated to pay the originally stated interest rate on the CDs. They don't care whom they pay the interest to.

I guess because of the "pre-owned" image, and because the previous owners took a hit when they sold before maturity, secondary CDs have a higher yield than new issue CDs. Who wants a used one when they can buy new for the same price? A secondary CD must be priced lower than a new CD. A lower price means a higher yield.

The previous owners' loss is my gain. I was able to pick up some good secondary CDs: 2.3% for 2-year and 2.95% for 3-year. These yields are almost as high as the best rates available elsewhere.

I paid more than the face value for some of the secondary CDs. Because the stated interest rates on those CDs are higher than the current market yield, I had to pay as much as $1,050 for each $1,000 CD. As I mentioned in the previous post, the amount I pay above the face value ("par") is not FDIC insured. The premium CDs have a risk for the "FDIC call" if the bank fails. For these CDs, I only buy if the issuing bank is too big to fail. I bought premium CDs issued by:

• LaSalle Bank N.A. – owned by Bank of America
• Wachovia Bank FSB – owned by Wells Fargo
• World Saving Bank – owned by Wells Fargo

I don't think FDIC will close Bank of America or Wells Fargo in the next few years.

I paid below the face value for two other CDs from banks I've never heard of:

• R-G Premier Bank of Puerto Rico (1-star on bankrate.com; 0-star on Bauer Financial)
• Carolina First Bank

Since the CDs are fully FDIC insured, I don't worry about the banks. When I pay less than the face value, I'll actually make more money if these banks fail. Let's see how long R-G Premier of Puerto Rico lasts.

Good secondary CDs don't show up every day. I use this bookmarklet to screen them. The bookmarklet opens three browser tabs. The first tab shows the new issue CDs. That's the benchmark. Secondary CDs must beat new issue CDs to become worthwhile. The second tab shows secondary CDs selling below face value. I don't have to worry about the banks for these CDs. The third tab shows secondary CDs from banks with a Moody's rating of A3 or above and a yield of 2% or more. If I'm paying a premium, the bank had better be strong and the yield had better be good.

Good secondary CDs also don't last long. One time I saw a good CD but I took about a minute to make up my mind. By the time I attempted to enter the order, it was gone. Someone else beat me to it.

Fidelity charges a small commission for secondary CDs: $1 per $1,000 CD and minimum $8 per order. Their quotes don't include the commission in the yield calculation until you are in the middle of placing an order. I made a spreadsheet to calculate the after-commission yield:

CD Ladder Spreadsheet

The spreadsheet also calculates the weighted average yield and duration for a CD ladder. If you like managing a CD ladder, you may find the spreadsheet helpful.

Treasure hunting in secondary CDs takes a little time. So does chasing yields by opening accounts everywhere. If you think it's too much trouble, you can just stick to a "good enough" place like Ally Bank or Alliant Credit Union.

[Ally Bank pays me $20 if you open an account from my affiliate link.]

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On Tuesday I mentioned the story about laid-off employees burning through their severance and turning down job offers. On Wednesday I read this article about people stopping using 529 plans because of market losses:

More Parents Are Becoming 529 Dropouts

[Link goes to Google. WSJ will display full article if you come from a link through Google.]

"in the wake of last year's market collapse and some high-profile fund blowups, some investors — and financial advisers — are paring back their reliance on 529 plans and in some cases are considering alternatives."

The article goes on to say people are investing in muni bonds, real estate, and fixed indexed annuities outside of the 529 plans instead.

To which I have to say "It's not 529's fault!" A few weeks back, there was an article on Times magazine about how 401k plan is bad and should be abolished. I didn't have time to comment on it back then. Now I just want to say "It's not 401k's fault!"

A 529 plan or a 401k plan is a container. Whether you make money or lose money depends on what you put in them. A plan is not an investment. When our mainstream media don't make this basic difference clear, no wonder the public is confused.

I also wonder if people came up with the ideas for muni bonds, real estate, and fixed indexed annuities on their own, or they were sold by some financial advisers. I suspect it's the latter.

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Life on Severance: Comfort, Then Crisis

* Link goes to Google. WSJ will display full article if you come from a link through Google.

It tells us stories about how some people coped with unemployment while on severance pay. The subjects in the article spent just like before, burning through their severance. They also turned down job offers because they didn't like the job description.

Let me know what you think.

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The mirror image of the marriage tax penalty is the marriage tax bonus, that is when two spouses have disparate income or one spouse decides to stay at home, they pay less tax than they do if they don't marry.

I touched on the topic of marriage tax penalty in two previous posts:

• Tax Proposals in Obama's 2010 Budget Outline
• 2009 AMT Tax Brackets

It turns out that marriage tax penalty and marriage tax bonus have been studied extensively by economics professors. It's well known within the academic circles that three desirable objectives can't be satisfied at the same time:

1. Horizontal Equity: households with the same income pay the same tax
2. Progressivity: higher income pays a higher rate of tax
3. Marriage Neutrality: the tax system should stay neutral to the decision to marry

It's very similar to the time-cost-quality triangle: you can have any two but not all three.

A key concept is called the unit of taxation, in other words, whether taxes are levied on an individual person or on a family.

The current US tax system uses a family as the unit of taxation. It achieves objectives #1 and #2, but it fails in objective #3. Some people receive a tax incentive to marry while others are penalized for marrying.

Most other developed countries use the individual as the unit of taxation. The same person pay the same tax whether they are single or married. This system achieves objectives #2 and #3, but not #1. Under this system, a one-earner household pays a higher tax than a two-earner household with the same income.

Although it seems unfair under an individual unit of taxation system to tax a one-earner family more than a two-earner family with the same income, it's actually fair. When you recognize the value of the household work taken up by the stay-at-home spouse, the one-earner family produces more and therefore should be taxed more.

According to a research paper I read, Canada, UK, Japan all base their taxes on individuals. Only 9 countries in 30 OECD countries base their taxes on families. In the last 30 years, several countries also moved away from joint taxation like in the US to individual taxation.

The United States is once again in the minority relative to the rest of the world on this issue. Why am I not surprised?

Reference:

Alm, James, 2005. Thinking About The "Marriage Penalty", a PowerPoint presentation.

Alm, James and Mikhail I. Melnik, 2004. Taxing The "Family" In The Individual Income Tax, Public Finance and Management, Vol. 5, No. 1

Cleveland, Gordon and Michael Krashinsky, 1999. Tax Fairness for One-Earner and Two-Earner Families: An Examination of the Issues. CPRN Discussion Paper No. F07.

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"It's a stock picker's market."

I heard a guest say this in a recent episode of WealthTrack. Is it true?

Absolutely. If someone picks the right stocks, they will have a better performance than the market. There's no doubt about it. It's a tautology.

In any market, whether it's going up, down, or flat line, there will always be stocks that do better than others and stocks that do worse. There will be stocks that do much better than the market and there will be stocks that do much worse. That's what makes up a market. If you happen to have picked the stocks that do better, you will do really well. Therefore it's a stock picker's market. It always is and it always will be.

There's only one small problem. The right picks are defined by whether they do better after the fact. You can have a thousand good reasons why a stock should go up. Just going up is not enough. It has to go up more than the market does. That's the holy grail. Whoever know the secret are not speaking. They are busy making money.

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I've never had a financial advisor. I'm guessing the percentage of the population who have a financial advisor isn't that high. If they all say people should check with their financial advisor, why don't most people have one?

1. Too many sharks. For those who have a financial advisor, I'm guessing again that most are not working with a fee-only advisor who acts as a fiduciary and only gives advice in the best interest of the client.

There are many salesmen and saleswomen out there selling expensive products to unsuspecting clients. Advisors who work in bank branches and "full service" brokerage firms are notorious for this. Ameriprise advisors don't have a good reputation either. When people can't tell an unbiased advisor from a salesman/woman, they are afraid of getting burned. They end up not using an advisor at all.

2. Too expensive. If people are not paying the advisor through expensive products, a fee-only advisor can still be expensive.

Some will take you only if you let them manage your investments and pay them 1% of your assets. Some won't take you at all if you don't have at least a six-figure minimum asset level. 1% on $100k is $1,000 a year. 1% on $500k is $5,000 a year. And that's just for investment. There's much more to financial advice than just investment.

3. Easy to DIY. If you set your mind on it, it's not that hard to learn about these financial planning topics, although the same can be said of almost anything: plumbing, exercising, lawn care, you name it.

You can educate yourself by reading books, newspapers, magazines, and now blogs, listening to radio programs, and watching TV and video. You can Google or get on Internet forums and message boards and get all kinds of information.

You have the same problem with not being able to separate the good from the bad if you don't know much about the subject to begin with. You still have to be able to apply what you read or heard to your own situation. By definition the books, radio and TV programs, blogs and Internet forums can only be generic. Thus the "check with your own financial advisor" CYA disclaimer.

For the most part, people are on their own. If news media reports are representative of what's happening in the real world, people on average are not doing a very good job at managing their finances. I would think we will be better off if we can get unbiased advice at an affordable price. The price paid for doing it right will be recovered many times over by avoiding costly mistakes. Still, given that there are many sharks out there and even good advice can be expensive, DIY seems to be the only viable alternative.

How much should unbiased financial advice cost? Suppose I convince you that you can trust me for giving you good quality, unbiased, individualized financial advice. What do you think should be a fair price?

Let's get specific. Suppose a couple want to save for college for a child. They want to know which account type (UGMA, Coverdell, 529, Savings Bonds, Roth IRA, regular taxable, etc.) they should use, which provider, and which investment options they should choose. What do you think they should pay? $0 because people can just Google? $5? $25? $100? $200? $500?

If you have a trusted advisor to whom you can ask unlimited number of questions and get advice whenever you need it, how much should it cost? $0? $10 a month? $20 a month? $50? $100? $200? $500?

I ask these questions not just as a hypothetical. I'm willing to help others with their personal finance questions. If I start giving individualized advice though, I'll have to become a licensed advisor and maybe get a CFP. I don't necessarily have to make much money from it (my full-time job covers my living expenses), but I do want to at least cover my cost of regulatory compliance and liability insurance. However, if people are not willing to pay much for such advice, obviously there's no point of getting licensed and certified and paying the associated costs.

So do you think there is an under-served market for unbiased financial advice? I can think of some friends and family members who can use some advice if it doesn't cost an arm and a leg.

Usually an under-served market exists when there is a big gap between what customers are willing to pay and what it costs to produce what they want. I suspect that's the case in the financial advice market.

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The title is The Bogleheads' Guide to Retirement Planning. It covers a wide range of topics on planning for retirement. The emphasis is on planning, not saving or investing for retirement, although there are still a few chapters on investing. It starts off with the planning process. Then it goes over the different savings and investment vehicles, investment strategies, how to make the most of social security, withdrawal strategies once you are retired, insurance, estate planning, how to find help if you need it and what to do if you face divorce or too much debt you can't repay.

I like the broad approach in this book. Retirement planning is a complex subject. There can be full-scale books on each of the topics covered in this book. Every chapter covers the main points in about 15 pages so the size of the book stays manageable. If the reader wants to read more about a particular subject, there are a list of additional resources at the end of each chapter. The book serves as a good roadmap for retirement planning.

My most favorite chapters in the book are "Single-Premium Immediate Annuities" by Dan Smith and "Early Retirement" by Jeff McComas.

Most (all?) of the chapter authors are not professional writers. All the royalties from the book are to be donated to charity. The authors invested their time and effort into this book only because they wanted to help the readers. There is no hidden agenda to sell anything. I appreciate the wealth of information shared in this book.

Despite whatever impression you may get from this blog, writing is one of my weakest skills. English not being my first language does not help either. It took me several weekends to write my draft chapter. Without the great help from the editors, it would not be publishable as it is now.

You can tell this is still a finance book. It does not cover much non-monetary aspect of retirement planning such as finding the ideal location one would like to retire to. It's heavy in information but light in step-by-step guides. There is no worksheet that helps one figure out the big numbers:

• Given what I have now and what I'm saving, when can I retire?
• If I want to retire in age X with a lifestyle budget of Y, am I saving enough now?

These are the things I will try to find out because I've set a goal for myself of retiring in 2020.

I would say this is a great book even though I'm biased because I participated in its creation. One of the best kept secret until now is the Bogleheads Wiki. The book mentioned the Wiki in many places. If you are not getting the book, at least bookmark the Bogleheaads Wiki. The depth of information on the Bogleheads Wiki is unbelievable.

[This post contains affiliated links to Amazon.com. Amazon.com will pay a commission of 4% - 6.5% to me if you make a purchase within 24 hours after you click on the link.]

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Congratulations, Austin!

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After rolling over my IRA to my solo 401k at Fidelity, I want invest a small sum in the solo 401k account in short-term fixed income. I went and looked at my  options.

Treasuries

I can buy Treasury notes from Treasury auctions. Fidelity doesn't charge me any fee for that. The problem is the yields are so low. According to Bloomberg, the current Treasury yields are:

If I buy an equal amount in these, my average yield will be 1.29%. I'd like to do a little better than that.

Bond Funds

Fidelity has a low cost short-term Treasury bond index fund. The problem is because it invests in Treasuries, the yield on the bond fund is also very low. A bond fund can't earn more than the underlying bonds do.

Fidelity also has a short-term bond fund which invests in Treasuries and government agency bonds (~40%), corporate bonds (~25%), and other bonds. It's more expensive. I'm also wary of the alphabet soup in the fund: MBS, ABS, CMBS, CMO.

Vanguard has a short-term investment grade bond fund. Fidelity charges $75 for the initial purchase and $5 for each subsequent purchase if I set up an automatic investment plan. The Vanguard fund invests less in Treasuries and government agency bonds (~10%) and more in corporate bonds (~60%). It also has about 20% in asset-backed and mortgage-backed bonds (securitized credit card and consumer loans). The yield on the Vanguard fund is little higher than the yield on the Fidelity fund because the Vanguard fund has less in Treasuries and more in corporate bonds, and because it's less expensive.

The duration of a bond portfolio indicates its sensitivity to interest changes and the amount of time it takes to recover from an interest rate increase. Because interest rates are low, I'd like to keep my duration low.

Bond ETFs

Like index funds, ETFs have low expense ratios. The commission on purchasing an ETF is a lot lower than the $75 Fidelity charges for buying a Vanguard fund. I already know a Treasury ETF can't do any better than Treasuries I can buy myself. If I buy an ETF, I'm only interested in a corporate bond ETF.

Vanguard Short-Term Bond ETF (BSV) is the ETF equivalent to its short-term bond index fund. It has 70% in Treasuries and agency bonds. iShares Barclays 1-3 Year Bond ETF (CSJ) invests primarily in corporate bonds. I like its portfolio. The problem is it trades at 1% premium to the underlying net asset value (NAV). If I put $10,000 in it, I'm paying an extra $100 plus a $11 commission. That's more than what I'd pay if I buy the Vanguard open-end fund.

CDs

CDs offer a unique advantage to retail savers. When you buy Treasuries or bonds, either directly or indirectly through mutual funds or ETFs, you are competing against institutional investors. They set the price; you follow. You may also pay a markup to some middlemen unless you buy in Treasury auctions.

Retail savers rule in CDs. Institutions with hundreds of millions to invest can't be bothered to open a $250,000 CD here and there. Treasuries will never be "on sale." On the other hand, different banks will have different eagerness to attract deposits at different times. When one bank wants money more badly than another, they will have a "sale" on their CD rates. As long as the CDs are FDIC insured, you don't care who's putting the CDs on sale.

If you don't mind the hassle of opening and closing accounts, you can shop the highest rates wherever they are. Bank Deals publishes a weekly summary of the best CD deals. Bank Deals is better than BankRate.com because Bank Deals does not limit itself to banks that pay its operator for the lead. As I'm writing this, the best deals I see on Bank Deals with a low minimum deposit requirement are:

If you compare these rates with the Treasury yields, you see the CD yields are much better. An equal amount in these CDs will earn an average yield of 2.86%, versus 1.28% in Treasuries. The best rate CDs have a higher yield and a lower risk than bond funds and ETFs that invest in corporate bonds.

Brokered CDs

Unfortunately opening accounts wherever the best deals are is not an option for me in my solo 401k account. My money has to stay within Fidelity.

Fidelity sells brokered CDs. These CDs are also FDIC insured. Instead of selling directly to individual savers, some banks sell their CDs through brokers. There is no fee for buying brokered CDs, but the best rates on brokered CDs don't match the best rates on retail CDs. Here's what I see in Fidelity:

There's quite a gap between these yields and the yields on best available CDs. If I put an equal amount in these CDs, I will have an average yield of 1.96%, still higher than the Treasury yields. The yield is somewhat lower than that on corporate bond funds and ETFs, but CDs have less risk.

Secondary CDs

Fidelity also sells secondary CDs. These are CDs other investors wanted to get out of before the maturity date. If I buy them, I take over the remaining term, very much like when one buys a bond on the secondary market. They are still FDIC insured. Fidelity charges a fee of $1 per $1,000 (min. $8). If the interest rate on the CD is above market, I will also have to pay a premium. I see these secondary CDs in Fidelity:

When someone wanted to get out early, they will have to offer a better yield than comparable new issue CDs. If I put an equal amount in these four CDs, I will get an average yield of 2.66%, higher than the yield on new issue CDs, matching the yield on corporate bond funds and ETFs with lower risk.

There is one caveat in secondary CDs: the FDIC call. The CDs are insured by FDIC for their face value plus accrued interest. If the CD's interest rate is higher than market and I have to pay a premium, the premium I pay is not protected by the FDIC. In essence, I'm short a call option at par to the FDIC.

For example, paying $1,052.71 for a $1,000 CD from Capmark Bank with an interest rate of 4.7% will give me a yield of 2.87% if Capmark Bank doesn't fail before the CD matures on October 29, 2012. If it fails tomorrow, I only get back $1,000 from the FDIC, and I lose $52.71. That's a risk in buying secondary CDs.

If I buy secondary CDs, I will limit myself to CDs selling below 100 or CDs issued by well known too-big-to-fail banks.

Structured Products

Savers don't like low interest rates. That's for sure. I was waiting for someone outside a bank branch the other day and I saw some brochures and forms the in-branch investment advisors stacked by the window: index linked CDs and absolute return funds. They are targeted at people who are not satisfied with their CD rates. People want something for nothing. The advisors in the bank branches have a ready audience.

If you want safety, go with safety. If you want to take risks on the stock market for its higher expected return, go with the stock market. Blend the two and you will have a balanced portfolio. The structured products only enrich the producers and the advisors. I won't touch them with a ten-foot pole.

After weighing all my options, I decided to do a mix of new issue brokered CDs and secondary CDs. This CD ladder I put together will have an average yield comparable to corporate bond funds and ETFs, but the CDs will have lower risk. The FDIC insurance comes as close to a free lunch as it can get.

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I had planned to sell them in January 2010 after they earn nothing for three months. Now it looks like I will hold them one more year until January 2011.

If I redeem them in January 2011 instead of January 2010, these April 2008 I Bonds will earn

• 0% for 3 months (1/2010 – 3/2010)
• 4.28% for 6 months (4/2010 – 9/2010)
• 0% for 3 months (10/2010 – 12/2010, last 3 months of interest forfeited)

Over the course of 12 months, they will earn 2.14%. Right now a good rate on a 1-year CD is slightly above 2% (Alliant Credit Union 2.15%, 2.30% if over $25k). The 1.2% I Bonds will earn about the same or slightly more because they are state income tax free.

I will revisit this decision in January. If there are better opportunities elsewhere, I still have a chance to change my mind.

Because of deflation in late 2008 early 2009, all I Bonds have to go through a period of earning 0%. If you are planning to sell your I Bonds before their 5-year anniversary, make sure you sell only after they earn 0% for 3 months. Because you forfeit the last 3 months of interest, you want to forfeit 0%, not your high positive rates. Here's a table showing when the 3-month 0% period is over:

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