#3: When You Can Get Benefits - II

Here’s a breakdown of when you can begin receiving Social Security benefits based on the type of benefit you are eligible for:

#3: When You Can Get Benefits - I

You can start receiving your own full retired worker benefit beginning somewhere between the ages of 65 and 67, depending on when you were born.

Spousal Benefits - II

If you are divorced and your former husband worked long enough to earn a Social Security retirement benefit, then you may be eligible for a survivor’s benefit if your marriage lasted at least 10 years and you are at least age 60 (50 if you are disabled). If you have been receiving benefits as a survivor and reach retirement age, you can switch to your own retired worker benefit if it is larger. In many cases, you can begin receiving retirement benefits based on your own work history at age 62 and then switch to the higher spousal benefit when you reach full retirement age. 

Many women face a harsh reality during their retirement years when their spouses die. Until then, a woman receives half of her husband’s retirement benefit as a spousal benefit, and her husband collects his own retirement benefit. When the husband dies, the wife begins receiving her husband’s benefit, but the spousal benefit goes away. It’s important to recognize this and plan ahead by saving more or purchasing an annuity to help lessen the financial impact of this drop in monthly income.

Spousal Benefits - I

If a married or divorced woman earns a benefit that is less than 50 percent of the amount her spousal benefit would be, or if she has no benefit from her own work years, she is eligible for a spousal benefit. This benefit is generally equal to half of her husband’s (or former husband’s) worker benefit. Until recently, the spousal benefit was the most common type of benefit received by older women. 

A divorced woman is eligible for spousal benefits only if her marriage lasted at least 10 years, she remains unmarried, and is at least age 62. This benefit has no effect on the benefits of a divorced woman’s former husband or his current spouse if he remarries. If you have earned benefits through your own work history as well as through spousal eligibility, you are considered to be “dually entitled.” But this doesn’t mean you get both benefits added together. If you qualify for more than one benefit, you will receive the benefit amount that is higher.

 Survivors Benefits If your spouse dies and he worked long enough to earn a Social Security retirement benefit, then you and your young children may be eligible for “survivors” benefits. If you don’t have children under age 16, you can collect:

• A survivors benefit at your full retirement age (your husband’s full retirement
benefit);
• A reduced benefit beginning at age 60; or
• A benefit beginning at age 50 if you are disabled.

Retired Worker Benefits

In theory, Social Security is set up to pay the same retired worker benefits to women and men with exactly the same work histories and earnings. But the reality is that women don’t typically have the same work histories and earnings as men, so their retired worker benefits are usually lower. Women have fewer work years that count toward Social Security benefits because they tend to move in and out of the workforce due to family caregiving responsibilities. That said, many women are eligible for a retired worker benefit based on their own work histories. Back in the 1940s, women made up only 12 percent of Social Security beneficiaries receiving a retired worker benefit. Today, 49 percent of retired worker beneficiaries are women—underlining the remarkable growth of women in the labor force over the decades. However, women often work fewer than the 35 years the full benefit is based on. As noted before, a zero is entered into the benefit calculation for each year under 35, which reduces the benefit amount. Women retiring today average 13 years of zeroes. All of this adds up to a major gender gap in retirement benefits. The average benefit for retired women workers in 2005 was $867 a month, compared to the average retired worker benefit for men of $1,130. This is a difference of $263 a month.

#2: The Types of Retirement Benefits Available

A woman is generally eligible for one of three types of benefits: her own retired worker benefit based on her work history; a spousal benefit based on her husband’s (or former husband’s) benefit; or a survivor benefit.

1 How You Earn Benefits

You are eligible for a Social Security retirement benefit once you have earned 40 credits, which for most people is after they have worked and contributed to the system for 10 years. Ultimately, your benefit is based on your earnings over 40 work years. For each year you don’t work in that 40-year period, a zero is entered into the calculation. The lowest five years of your earnings are dropped, and retirement benefit amounts are based on your income averaged over 35 years. Since Social Security first arrived on the scene (more than 70 years ago) millions of women have not qualified for their own benefit as retired workers because they didn’t work enough years. For women who have qualified, their benefits have been low due to the number of years they spent out of the workforce (for example, raising a family or taking care of parents or in-laws) and because women generally earn lower wages. In these cases, Social Security has provided a “spousal benefit” to married and certain divorced women based on their husbands’ work histories. The next section covers spousal benefits in detail.

Chapter Four: Six Things You Need to Know about Social Security

Most workers—about 96 percent of us these days—pay into the Social Security system through federal payroll or self-employment taxes. In return, we receive an income benefit when we retire. Social Security benefits rise with the cost of living, so inflation doesn’t shrink their value. Once you begin receiving retirement benefits, you will get them as long as you live, even if (and here’s hoping) you’re still around at age 110. (Social Security is also a disability program and a family support program if the breadwinner dies or becomes disabled. But in this chapter we’ll only be discussing the role it plays in providing retirement income benefits for older Americans.) After reading this chapter, you’ll know:

1. How you earn benefits
2. The types of benefits available
3. When they’re available
4. How much you qualify for
5. How taxes affect your benefit
6. How to apply for your benefits

Why is it important for you to know these six things? Because Social Security is the first line of defense against poverty for millions of women. Without Social Security, more than half of the older women alive today would be poor. These women are our grandmothers and mothers, our aunts, and our neighbors. And eventually, we could be those women. Consider knowing these six things about Social Security as your line of defense against poverty in retirement.

Conclusion

In the end, how well your money works for you depends on your understanding of the fundamentals. Knowing, for example, to focus on fees and avoid sales commissions will improve your returns. Understanding the risks that come with different types of investments can help you invest in a way that makes sense for your time horizon and the amount of risk you are willing to take. No one ever said that understanding stocks, bonds and investing is easy, but it also isn’t as hard as a lot of people think. Knowledge is power, and you now have the power to take control of your financial future. So—go forth and invest!

Finding Good Advice

Many people discuss their investment choices with a financial advisor. Keep in mind that there are numerous types of advisors and many have vested interests. Stockbrokers and bank employees usually earn a commission if they sell you certain types of investment products, even if these products might not be the absolute best fit for your needs. Financial planners usually charge a fee—this is often a small percentage of your portfolio’s value, much like the expense ratio that mutual funds charge. Sometimes, however, a planner will ask you to pay a fixed sum of money for a certain service, or will charge an hourly rate. In general, advisors who work on a “fee-only” basis have fewer conflicts of interest. This doesn’t mean advisors who charge commissions are bad; it’s just something you should be aware of. If you decide to go it on your own, you can narrow your choice of funds with an online “screener.” This is a computer tool that researches funds based on criteria you set and produces a list based on those criteria. Many Web sites host free screening tools. For example, you could search for growth funds with no loads and an expense rate no higher than one percent. If the list is too long, add more criteria to narrow it down.

Diversification Is Key

It all depends on the amount of risk you’re willing to live with and the amount of investment income you need to live on in retirement. For example, if you have many years left to let your money build up before you retire, and if you’re willing to take a chance, you may want to put a bigger percentage of your money in stocks or other investments that offer relatively high rewards at higher levels of risk. On the other hand, if you expect to retire in a few years and you don’t want to risk losing any savings, you’ll probably want to keep a good portion of your money in safer investments like bond funds. Your money won’t grow as fast as it would if you put everything into stock funds, but you don’t want to risk your hard-earned nest egg when you’re so close to your goal. The other factor to consider is how much risk you can stomach. Remember, small company stocks tend to be riskier on average than blue-chip stocks. Finding Good Advice Many people discuss their investment choices with a financial

How Do You Choose?

With thousands of mutual funds—investing in stocks or bonds—currently on the market, you can find yourself dragged down by the sheer number of investment choices available. Even the experts have a hard time agreeing on which funds the typical person should buy. We’ve already seen that in the long run, fees are the critical factor. The big question is what funds are right for you?

The Big Secret of Bond Funds: Fees Matter More

Research has proven that the skill of a bond fund manager is a less reliable predictor of future performance than one simple fact: how much his or her fund charges. This is true for many of the same reasons that we’ve covered with stock funds, but added factors make it even more important when we’re dealing with bond funds. All other things being equal, stick with bond funds that charge the lowest fees you can find.

What Are the Different Kinds of Bond Funds?

As with stock funds, fund companies have created bond funds tailored to suit many different investment interests and tax brackets. Some concentrate on bonds issued by low-risk borrowers with rock-solid credit to provide a relatively low but steady income. Others take a chance on somewhat shakier issuers (again, junk bond funds come to mind here) and hope that the high yields will make up for any defaults. Some bond funds take a long-term approach, while others will only look at short-term debt. Most bond funds invest in government or corporate bonds; these funds are also called “taxable” bond funds. Some invest only in state and local government bonds (which, remember, are generally not a wise investment for investors in low tax brackets). 

Just as it is essential to consider expenses and fees when investing in stock funds, it’s just as important to do so when evaluating bond funds. The average taxable bond fund charges an expense ratio of 1.1 percent; this can be a very high cost relative to the return you receive, particularly in an environment where interest rates are low. In contrast, the best bond index funds (bond funds that attempt to invest in broad market indices representing all bonds) often charge less than 0.2 percent a year.

What Is a Bond Mutual Fund?

Since most types of corporate and government bonds (with the exception of savings bonds) carry a price tag of $1,000 or more per bond, it can be hard for the average person to put together a truly diversified bond portfolio. 

The sheer variety of bonds available also makes it difficult to choose which ones are best for you. Should you buy a one-year bond or a 30-year bond with your $1,000? Should you buy it from the government or a corporate issuer? 

And if the bond is from a corporate issuer, which one should you choose? Many mutual funds invest in bonds. Just as bonds are less risky than stocks, bond mutual funds tend to be less risky than stock mutual funds, but pay generally lower returns. 

There are exceptions. Junk bond funds, for example, can be as risky as many stock funds. It is critical to understand one thing: Unlike an individual bond that you can hold until maturity, a pool of bonds has no maturity date. With a bond fund, there’s no guarantee that as of a given date, you will receive your investment back. If the fund managers make bad trades, you could end up losing a lot of money.

Buying Individual Bonds

If you have more money to invest and can stomach a little more risk in order to get a higher return, there are a few things you need to consider. 

The government sells marketable securities, known as Treasury bills, notes, bonds, and TIPS (Treasury Inflation-Protected Securities), with maturities ranging from one month to 30 years. Treasury securities are considered among the safest in the world in terms of default risk, but tend to pay a slightly higher coupon rate compared to savings bonds or I Bonds. You can buy these in $1,000 increments from the government’s TreasuryDirect.gov Web site. You can buy them from a broker as well (see below), but it’s cheaper to get them direct from the source. To tempt investors away from the relative safety of Treasury bonds, other issuers have to offer higher coupon rates—and the riskier the issuer, the higher the rate. 

For example, agencies like the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) issue bonds that aren’t officially backed by the U.S. Treasury, and so carry a higher coupon rate. State and local governments also issue bonds to fund various projects, again with a somewhat higher risk of default. 

Most of these bonds also carry lower coupon rates than federal government bonds, however the interest on these bonds is generally exempt from federal income taxes and (in some cases) from state and local income taxes as well, which makes them more desirable to investors in high tax brackets. Generally, these bonds are not a wise choice for lower-income investors. It is important to compare returns on an after-tax basis. 

Corporations and foreign governments also issue bonds. Much like people, different companies, countries, and government issuers have different credit ratings that gauge the likelihood that they’ll be able to meet their debt obligations. In general, the better the credit rating, the lower the risk of something going wrong—and usually, the lower the coupon rate will be. 

You can buy corporate bonds from a broker, usually in $1,000 chunks, but it can get very expensive, especially if you’re only buying a few bonds at a time. Bonds purchased through brokers often include a mark-up in price that is imbedded in the transaction cost. Every broker has different rules and charges different fees; in general, expect to pay a minimum of $20 to $50 or more, depending on how many bonds you’re buying. The added cost of purchase reduces the effective yield you receive on the bond.

Savings Bonds: Super-Safe Alternatives

If you want to get into bonds for a relatively small amount of money, the government still sells traditional U.S. savings bonds (now called EE Bonds). Savings bonds are extremely safe, but the trade-off is that they pay a fairly low interest rate, currently 3.6 percent. The minimum you need to invest in EE Bonds is $25. They’re available in increments of $25 from banks, or in any amount of $25 or more (up to the annual purchase limit set by the Treasury) from www.TreasuryDirect.gov. All EE Bonds will pay monthly interest for up to 30 years, but unlike Treasury bonds, you won’t be getting a check every six months—you need to cash them in (also called redeeming them) to get the money. You can redeem these bonds at any time after one year, but beware: If you cash in a savings bond before five years, you’ll have to pay a penalty of three months’ worth of interest. Another type of savings bond that anyone can buy is Series I savings bonds—I Bonds, which are like traditional savings bonds with an extra shield against inflation. In late 2006, I Bonds paid 1.4 percent in interest above inflation, which the government re-measures every six months before announcing the new rate. If the official rate of inflation comes in at 3.1 percent (for example), new I Bonds would yield that amount plus 1.4 percent, or 4.5 percent. Unlike EE Bonds, I Bonds are sold at face value and accumulate interest over time. You can start buying I Bonds with as little as a $50 initial investment from a bank or as little as $25 through the TreasuryDirect program. They can be cashed in any time after a year, up to 30 years after you buy them. As with EE Bonds, there’s a three-month interest penalty if you cash them in before five years. Savings bonds are non-marketable, meaning that they cannot be sold in the secondary bond market. They can only be redeemed for their current value from the Treasury or a Treasury agent (which includes most financial institutions).

How Can You Invest in Bonds Wisely?

It’s generally considered a good idea to invest at least some of your retirement money in bonds. After all, bonds can provide steady income while helping to protect your principal from potential losses. However, the range of options available can be confusing.

The Risks of Bonds

One of the main risks of a bond is the possibility that financial trouble could make the bond’s issuer unable to pay the interest or even give you back your principal as originally agreed. The issuer may even declare bankruptcy. If this happens, the issuer defaults on the debt it owes you, which can make it difficult or impossible to get all of your money back. Different issuers carry different risks. The highestquality bond issuer is the U.S. government. 

A superior credit rating makes Treasury bonds the safest investment in the world when it comes to default risk. Corporations, in contrast to government issuers, must depend on their revenues to repay their debt, which means that strong and large corporations will generally be considered better bond credit risks than smaller, less profitable companies. 

Some low-quality issuers can only offer what are called high-yield or junk bonds, which can provide high rates of interest, but also carry the risk of paying nothing at all if the issuer defaults. Bond investors are also affected by inflation. The problem here is that the interest rate bonds pay is locked in when you buy them, so if everyday prices go up too fast before the bond matures, the money you get back won’t go as far as it did when you bought the bond in the first place. Say you buy a $1,000 bond with a term of one year and a five percent coupon rate. 

When the bond matures, you’ll have earned $50 in interest. Unfortunately, if the price of everything climbs three percent during those 12 months, your $50 only has the buying power of $48.50 in next year’s dollars (this “after-inflation” value of an investment is called its real return). Furthermore, when you get your $1,000 back, its buying power will have shrunk also. You haven’t technically lost principal, but you haven’t done quite as well as it might look on paper. And if you depend on income from your bonds to pay your living expenses, you could have to cut back if faced with rising inflation. Inflation forecasts are always changing as the market receives new information about the way prices are going. 

The quality of a bond can also change if something happens to make the issuer more or less able to pay its debts. New bonds are always being issued at whatever interest rate people are willing to accept in return for the loan of their money, and old bonds are always changing hands as investors look for a better deal.

How Bonds Make (and Lose) Money

Bonds are generally considered less risky than stocks for a number of reasons, but they aren’t a risk-free place to invest your money. When you own an individual bond, you generally have two choices: You can buy it and hold it until it matures, or you can sell it for a profit (or a loss). Sometimes investors decide to sell a bond before it matures. Perhaps they’ve found a better place to put their investment, or maybe they simply want (or need) to get their money. In this case, they may have to take a loss if they can’t find a buyer willing to pay face value to buy the bond. 

Of course, this process also works in reverse. If enough people want to buy your bond—because its coupon rate is higher than prevailing rates on similar types of bonds—you can sell it for more than its face value and collect a profit. This sort of active trading approach to bonds can be risky, however, and is best left to the experts. If you follow the news from the bond market, you’ll probably hear a lot of talk about how the “yields” on various types of bonds are changing from day to day. 

The current yield is simply a way to express as a percentage the interest rate a bond would actually pay if you bought it at the current market price, as opposed to the coupon rate it offered people who bought it at face value when it was first issued. As an example, take a $1,000 bond with a coupon rate of five percent. No matter what price it trades for, it will still pay five percent of its original value, or $50 in interest a year. If, for any reason, demand for that bond increases to the point where people are paying $1,100 for it, those people would receive a current yield of that $50 interest payment divided by the current market price ($1,100), or about 4.5 percent.

Bonds 101

If a share of stock represents ownership in a company and its profits, a bond is basically a temporary loan that you make to a company, the US Treasury, or a local government entity. Bonds are created when an organization (called the issuer) decides that it wants to borrow a certain sum of money from investors. As with any other loan, the issuer promises to pay the money back after a fixed period of time (a term) and agrees to pay the investors a fixed interest rate as well. 

This rate of interest, expressed as an annual percentage, is called the coupon rate. The total amount of debt that the issuer is taking on is then divided up into smaller chunks, each representing a fixed dollar amount of the money being borrowed (the face value) and sold to investors. These are the bonds. 

At the end of the term, a bond matures and the issuer repays the original money borrowed. However, because you can buy or sell bonds like shares of stock, the person holding the bond at maturity may not be the original buyer. In the meantime, the issuer keeps making interest payments to the current bond owners.

The Big Secret of Stock Investing: Fees Matter

Now that you know the stock basics, you’re ready for perhaps the most important information in this chapter: fees matter. There’s nothing magical about index funds. If the index they track goes up, the fund goes up with it, and you make money. If the index goes down, the fund goes down, and you lose money. Actively-managed funds tend to be a lot more expensive than index funds, and these added costs take a bite out of the money that these funds can make for you. Every mutual fund company charges its investors an annual fee in order to cover its costs, pay its managers and other employees, and make a profit. This fee, called the expense ratio, varies widely from fund to fund, but is always a percentage of the money you have in a particular fund. For example, if you have $1,000 invested in a fund that carries an expense ratio of 1.83 percent, the fund company will automatically deduct $18.30 from your account. In late 2006, the average actively-managed stock mutual fund carried an expense ratio of 1.49 percent, or $14.90 on every $1,000 you invest. On the other hand, you can find index funds that charge as little as 0.07 percent, or 70 cents on every $1,000. While performance will vary from fund to fund and from year to year, this fee gap means that, everything else being equal, your actively-managed fund has to beat the index fund by an extra 1.42 percent every year just to break even. Over the long haul, there aren’t too many active managers who can do that. If you invested $1,000 in an index fund and your friend invested the same amount in an activelymanaged fund—both returning the same eight percent per year—after 10 years, you’d have $266 more than your friend because the average managed fund costs so much more than the index fund. Go back to 20 years ago, and you’d be ahead by $1,071 today. Whether you choose an index fund or an actively-managed fund, focus on lower fees. Many mutual fund companies also make investors pay an added fee called a load. There are several types of loads, but they all boil down to a sales charge or commission—again, a percentage of your investment—that you pay either to buy into a fund or sell your shares. There’s no evidence that funds that charge a load do any better over the long run than those that don’t, so you should definitely avoid the added fees whenever you can. There are over 2,000 noload funds to choose from.

What Is a Stock Mutual Fund?

Unless you are willing to bet on individual stocks, funds are probably the way to go. Stock mutual funds will invest in individual stocks for you, while spreading your risk. You can still lose money, but it’s generally less risky than choosing a single company’s stock. It would be hard to find two stock funds that are exactly alike. Large-cap funds invest in only the biggest companies (generally, these companies are worth tens or even hundreds of billions of dollars) while small-cap funds focus on smaller ones. 

Mid-cap funds, naturally enough, fall somewhere in the middle. International funds invest in foreign stocks; some concentrate on just a specific country. There’s a whole group of emerging markets funds that invest in stocks from countries that have yet to develop their economies to the extent of areas like the United States, Japan or Western Europe. Specialized sector funds focus on a particular industry, like technology or health care. Every stock fund has its own investment approach and its own balance of risk to potential returns. However, the main distinction you need to know is between actively-managed funds and their passively-managed (or index) counterparts. 

As their name implies, actively managed funds are run by people who take an active hand in managing their investments. These managers are constantly making decisions about which stocks to buy, which ones to sell and which ones to hang onto. 

When you invest your money in one of these funds, you’re really betting on the managers’ ability to buy the right stocks. Index funds are considered “passive” because their managers simply buy the stocks that make up a specific market index, like the S&P 500. They don’t make any active decisions on which stocks to own, and so they don’t have the costs of actively-managed funds for things like research or high-powered investment advice. This translates into savings for you in terms of lower overall fees over the long run. Even the best active manager can have a bad year, and there’s no guarantee that you’ll be able to pick the best manager. Over the long haul, research shows that you would generally be better off investing in index funds that follow the stock market as a whole.

What Are Mutual Funds?

A mutual fund is a financial product that combines the money of many individuals like you. The company that operates the fund collects the money and keeps track of how much each person puts into the pot. Professional investors called fund managers determine what to buy with the money to deliver the best returns they can find, depending on the type of mutual fund. Some funds concentrate on various types of stock, while others hold bonds (more on those in a moment). Because most mutual funds bring together tens or even hundreds of millions of dollars, fund managers have the money to spread out among many investments such as different stocks, for example. This is an advantage because it means that as an investor in the fund, you own a small slice of each of those stocks—possibly as little as a fraction of a share, but still some real amount worth a certain amount of money. In other words, by dividing your savings into all of these small investments, mutual funds let you diversify and reduce the risk that you’ll lose big if one of those stocks melts down

How Can You Invest in Stocks Wisely?

Now that you have an overview of what stocks are and understand some of the factors that make their prices move, it’s time to start talking about how you can invest in them. In general, most individual investors should avoid owning individual stocks, because if you bet most of your money on the health of a single company, you become vulnerable if something goes wrong with that company

The Dow Wilshire 5000

index is even more extensive, covering a large percentage of the stocks traded on the major exchanges. Despite its name, the Dow Wilshire 5000 is actually made up of approximately 6,700 stocks, drawn from a wide range of small, medium, and large companies. Its goal is to track practically every publicly traded stock, so it is often called the “total” market index.

The Russell 3000

brings together 3,000 stocks that account for about 92 percent of the value of the entire stock market. They trade on both the NASDAQ and The New York Stock Exchange (NYSE).

The Nasdaq Composite Index (Nasdaq)

contains about 3,100 of the more than 4,000 stocks that are bought and sold on the electronic NASDAQ network. This is the index that included many of the most famous (and infamous) high-tech and Internet companies of the late 1990s There are more indexes than the “big three” that offer investors options.

The Standard & Poor’s Index of 500 Stocks (S&P 500)

provides a wider sample of the market. When this index was created back in 1957, those 500 companies accounted for about 80 percent of the total value of all American stocks, and even today, this index provides a fairly accurate look at what’s driving the stock market as a whole.