Qubes. StreetTracks. HOLDRs. Names of popular rock groups? Not even close. They’re all investments called exchange-traded funds (ETFs) and many people use them to build a diversified portfolio. Maybe you should, too — if you understand the risk/reward trade-offs.

An ETF is a basket of securities, shares of which are sold on an exchange, such as the American Stock Exchange. They combine features and potential benefits of stocks, mutual funds, or bonds. Like individual stocks, ETF shares are traded throughout the day at prices that change based on supply and demand. Like mutual fund shares, ETF shares represent partial ownership of a portfolio that’s assembled by professional managers.

Types of ETFs

There are a number of ETFs, each with a different investment focus. Following are some common types of ETFs.

• Diamonds follow the 30 large-cap companies that make up the Dow Jones Industrial Average.

• Standard & Poor’s Depositary Receipts (Spiders) mirror the S&P 500, an index of 500 of the largest companies in the United States. They also track select sectors of the S&P 500.

• iShares hold baskets of stocks in specific regions of the world, select countries, or sectors, or follow U.S. corporate or government bond securities.¹

• Qubes track the 100 largest businesses of the technology-driven Nasdaq Composite Index.

• StreetTracks replicate various indexes focused on sectors, countries, or investment style.¹

• Holding Company Depositary Receipts (HOLDRs) are ETFs with a twist. They usually focus on narrow, emerging sectors — companies building the Internet infrastructure, for example — and their baskets hold only about 20 stocks to begin with. Stocks will never be added, and over time a HOLDR’s basket can become even more concentrated, as stocks that are lost due to mergers aren’t replaced. HOLDRs also differ from most ETFs in that they only trade in lots of 100 shares and shareholders can exchange their shares for the underlying stocks at any time by paying a fee.

Investors should note that because many HOLDRs are narrowly focused, they can be more volatile than other types of ETFs. Also, HOLDR investors will receive annual reports and other investment-related information for each of the 20 stocks in their HOLDR basket. On the other hand, they’ll only pay one brokerage commission instead of 20.

Different Structures

Originally ETFs were organized as unit investment trusts (UITs). In a UIT, an investment company buys a fixed portfolio of securities and then sells shares of that portfolio to investors. This type of structure results in dividends being held in an interest-bearing account, which are deposited into the ETF once each quarter. The delay in investing dividends can have a slightly negative effect on the total return of the ETF because the dividends are held as cash instead of being invested. Spiders, Diamonds, and Qubes are all organized as unit investment trusts.

Other ETFs, such as iShares, Select Sector Spiders, and StreetTracks, are structured as open-end funds. This arrangement follows the typical mutual fund structure in that new shares are continually offered and redeemed by the investment company. An open-end structure allows dividends to be reinvested immediately.

Evaluating ETFs

These investments offer a number of potential advantages, including:

Tax efficiency – ETFs may be more tax efficient than some traditional mutual funds. A mutual fund manager may trade stocks to satisfy investor redemptions or to pursue the fund’s objectives. Selling shares may create taxable gains for the fund’s shareholders. Because ETFs are like stocks, redemptions aren’t an issue. In addition, managers of index-based ETFs only make trades to match changes in their index, which may mean greater tax efficiency.

Low expenses — ETFs that are passively managed (managers usually only trade shares to mirror underlying benchmarks) may have lower annual expenses than actively managed funds.

Flexible trading — Like stocks, ETFs are sold at real-time prices and trade throughout the day. Mutual funds, on the other hand, do not have this flexibility: Their pricing is based on end-of-day trading prices.

Can be sold short and bought on margin — Because ETFs trade like stocks, investors can use them in certain investment strategies, such as selling short and buying on margin. Traditional mutual funds do not allow shorting of stock or margin trading.

No minimum investment — Most mutual funds require a minimum investment, whereas an investor can usually purchase as few shares of most ETFs as desired.

Diversfication — An ETF may be a good way to add diversification to your portfolio. Buying shares of a technology sector ETF, for example, could potentially be less risky than purchasing shares of one technology stock — an ETF may own shares of many different technology companies.

Of course, as with all investments, ETFs may involve risks and other potential drawbacks. Consider these factors before investing:

The trading flexibility of ETFs may encourage frequent trading. That could lead to the possibility of mistiming the market (moving stocks in and out of the market at the wrong times).

Brokerage commissions are incurred. For this reason ETFs may be better suited for a buy-and-hold investor or someone who is buying a large number of shares at one time, rather than for an investor who uses a systematic investment program.

There may be capital gain distributions. At times some ETFs have distributed taxable capital gains usually because the managers have needed to buy or sell stocks to match their underlying benchmarks. Additionally, government bond ETFs are subject to federal income tax.

You should carefully consider the risks of different ETFs. Many sector ETFs, for instance, will tend to be more volatile than an ETF that tracks the broader market. Check with a financial professional to be sure that you understand the risks and have the most up-to-date information before investing in an ETF.

Points to Remember

1. Exchange-traded funds (ETFs) offer potential benefits and risks of both mutual funds, stocks, or bonds.

2. ETFs have different types of structures: Some are set up as unit investment trusts. Others are structured like open-end mutual funds, and dividends are continually reinvested.

3. Advantages of ETFs include potential tax efficiency, low expense ratios, flexible trading, and portfolio diversification.

4. Disadvantages of ETFs include occasional distribution of capital gains, brokerage commissions, and the potential for frequent trading, which could lead to mistiming the market.

5. ETFs may be better for a lump-sum investor with a long time horizon than someone who trades frequently and/or invests at regular intervals.

Investors in international securities are sometimes subject to somewhat higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities. Sector funds are subject to increased volatility due to their limited diversification compared with other stock funds.

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© 2011 McGraw-Hill Financial Communications. All rights reserved.

April 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Martin V. Higgins, CFP, CLU, AEP , a local member of FPA.

Of late, you can’t watch cable news for a day without seeing more advertisements about owning gold than you used to see in a year. That should tell you something. Because whenever an “investment” concept or idea gets so hot that it pays vendors to spend hugely increased advertising budgets—to get while the getting is good, as it were—you can be pretty sure that concept is in full-on bubble mode.

You will not have failed to notice that you never see wall-to-wall ads for something which is deeply out of fashion, with its price falling and therefore its long-term potential value increasing sharply. Last March, for example, you saw not one ad trumpeting a “50%-off sale on the great companies in America! Buy now—this sale can’t last!” That would have been (a) true, and therefore (b) a total waste of advertising dollars, as equities were so cheap precisely because they were universally considered an instant, fast-acting carcinogen at that time. That’s why they were such a good buy. Ad dollars are best spent on the easiest sale; the easiest sale is always whatever is most in vogue; in investing, the phrase “in vogue” is always interchangeable with the phrase “too late.”

Gold is quite wildly in vogue these days, as the apocalypse du jour—the next crisis which is sure to envelop us all—is popularly held to be inflation: literally, the depreciation of paper currency, and a concomitant rise in the price of hard assets like precious metals. And, like all possibilities that get spun into cataclysmic certainty in the mainstream media, there is even some basis in fact for this.

The United States, in running unprecedented deficits, does indeed threaten the debasement of the dollar, and in fact the dollar’s trend has been down against the other major world currencies—and against commodities—for some time. What’s astonishing is not this premise, but the conclusion that people draw from it: that because an increase in inflation may happen, it will certainly happen. And that gold—making “new historic highs” every day—is the sure bet to get inflation working for you instead of against you.

There is a certain childlike quality to this “reasoning”—as indeed there is to all investment bubbles. It’s a sweet, logical little story that anyone can understand. And all you have to do in order to subscribe to it is completely to ignore the entirety of the historical record.

Let’s begin with the notion of gold as an inflation hedge. In a very long-term sense, gold has, in fact, been a mildly efficient antidote to the erosion of purchasing power. It is axiomatic that an ounce of gold has historically bought a good men’s suit. It did so in London in 1700 and 1800, and in New York and London in 1900 and 2000. I checked the bespoke suit department at Barney’s here in New York over the Christmas shopping season, and found this relationship to be holding, though just barely.

But the idea that gold has a good record in more recent periods—and that equities have a bad record—is simply ludicrous.

Return with me now to that thrilling day of yesteryear: January 21, 1980—very nearly thirty years to the day before you read this. (You want to start training yourself to think in thirty-year clips, by the way, because that’s about the length of the average two-person American retirement that’s starting around now.) That was the day gold hit its previous bubble peak—its “record new historic high,” as journalism likes to call it—the last time around. It topped out at $850 an ounce.

Now here’s the really fascinating part. If gold had functioned as an efficient inflation hedge in the interim—that is, if its nominal dollar price had risen in lock-step with Consumer Price Index inflation, thereby offsetting it—it would have to be selling today at about $2266 per ounce.

It isn’t. As I write, a few days before Christmas, it’s $1110, and the “all-time record new historic high” of recent headlines was about $100 an ounce higher than it is now. Just to give gold the benefit of the doubt, do you want to call it $1250 an ounce?

Fine. At $1250 an ounce, the real price of gold, adjusted for CPI inflation, has fallen about 45% in the last thirty years. At $1110, of course, it’s down over half. (If you want to perform this calculation for yourself, go to the wonderful website www.measuringworth.com/uscompare. It lets you calculate by calendar year, so I did 1980 through 2008, and then added two percent as a plug number for 2009 CPI inflation.) Classics Illustrated comic books were a far better inflation hedge than that.

As were—hold on to your hat—common stocks. On January 21, 1980, the S&P 500 closed at 112. To have hedged against inflation—to have gone up in lock-step with the CPI, thereby offsetting inflation—the S&P 500 would have needed to rise to a tad more than 300 by year-end 2009. As I write, it’s 1100. That is, the real price of equities, adjusted for CPI inflation, has risen something like three and a half times in the last thirty years.

And of course, equities paid dividends. You had to pay to store gold.

What does any of this prove? Probably nothing, in the sense that the past—and especially any thirty-year clip of the past—doesn’t prove anything about the future. But it is highly suggestive of a couple of important truths. The first is that, if you’re going to invest in something that’s supposed to be a near-perfect inflation hedge, you’d better make real sure that it has, in fact, hedged inflation with some consistent efficiency. And the other is that there’s nothing like buying into investment fads to insure wildly substandard returns for years, and even decades, to come.

Next time you see six different ads for gold in one broadcasting day, these might be two really good things to bear in mind.

© 2010 Nick Murray. All rights reserved. Reprinted by permission.

Though grandparents are among the millions who have taken a big hit to their portfolios in recent years, careful planning can ensure a healthy contribution to the education and financial future of their grandchildren.

The first step involves a talk between grandchildren and their adult children. According to 2008 research from The Hartford Financial Services Group, 65 percent of grandparents surveyed reported that they plan to contribute financially to their grandchildren’s college education, but that less than one third of all survey participants talked with their adult children about those plans.

Statistics show the amount of money that changes hands between grandparents and their grandchildren is substantial even before the kids head off to college. Hartford reports that more than 40 percent of grandparents spend more than $2,000 annually on their grandchildren before they reach 18 years old. And once it’s time for the kids to head off to school, over half of grandparents who plan to contribute will give more than $10,000, with a quarter of those planning to give more than $30,000.

A visit to a CERTIFIED FINANCIAL PLANNER™ professional can help grandparents and their adult children coordinate a gifting strategy that makes sense. In the meantime, there are several options to consider:

Talk: Adult children and their parents might find it difficult to talk about money issues in general, but discussing a positive goal like funding a child’s future can pave the way to make discussions later about the grandparents’ estate issues and end-of-life care a little easier to handle. But initially, these discussions will hopefully deliver a reality check. The Hartford survey points out that 60 percent of the grandparents surveyed believe that financial aid will be the most likely way their grandchildren will pay for college in an era where federal aid is declining and grants and scholarship cover only an estimated 15 percent of total college costs.

Start early: While many families don’t turn to relatives for help until there’s an immediate need, earlier planning almost always produces better results. Grandparents already know that saving for a child’s college education is easier if it starts at birth. The same is true for the next generation, so grandparents or adult children need to set a plan in place as early as possible for maximum benefit.

Coordinate college support with overall estate planning: Grandparents should look at their support for their adult children and grandchildren as an overall part of their estate strategy. A CFP® professional, in concert with estate and tax experts, can help grandparents and their adult children settle a series of estate issues at one time, saving time, money and worry later.

Consider the 529 plan option: A 529 college savings plan is an investment vehicle operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Service Code, which created these plans in 1996. If parents have set up a 529 plan for their child, grandparents can contribute to that plan or they can set up their own 529 plan account with their grandchild as the beneficiary.

Watch the fees: No matter what savings or investment options you choose, make sure you’re not overpaying fees. A stock mutual fund may charge in excess of 1 percent of assets; you can certainly find quality mutual funds that charge less. Two good resources: Morningstar.com can provide you a general review of most mutual funds you might be considering. The second is the Security and Exchange Commission’s online Mutual Fund Cost Calculator () which can help you determine how the fees and other costs associated with the fund will add up over time.

Offer some investing training wheels: Grandparents have a unique relationship with their grandchildren. They can teach without “lecturing” like their parents, and for that reason, they might consider setting up an investment account with a small balance that the kids can monitor and discuss under the supervision of the grandparent.

Make the grandkids beneficiaries: Naming your grandchild as the beneficiary of a retirement account or insurance policy can be a tax-smart way to provide financial support for college or possibly a first home.

October 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins, CFP, ALU, AEP, a local member of FPA.

A May survey by Hewitt Associates noted that despite record losses in their 401(k) savings in 2008, individuals stuck with their 401(k) plans. However, more people dealt with their worry about investment conditions by shifting money into more conservative investments. In addition, a significant number of companies either eliminated or cut back significantly on matching employee 401(k) contributions.

Hewitt’s annual Universe Benchmarks study, which examines the saving and investment behaviors of more than 2.7 million employees eligible for 401(k) plans, showed that the average 401(k) balance dropped from $79,600 in 2007 to $57,200 at the end of 2008. 44 percent of employees lost 30 percent or more of their savings. Only 11 percent of employees were able to break even or see a gain in their 401(k) portfolios. Even still, 74 percent of employees participated in their 401(k) plans in 2008, about the same as in 2007.

However, the Hewitt survey stated that some workers are reacting to the market downfall by moving 401(k) assets into less risky investment funds to try and blunt their losses. In 2008, 19.6 percent of investors made trades in their 401(k) plans versus 18.7 percent in 2007. And the volume of money they transferred in 2008 was much higher. Nine of the 10 most active trading days were the day after a large downturn in the market, or days with an average return of negative 4 percent. Employees’ average equity exposure dropped to just 59 percent in 2008—which is an all-time low since Hewitt began tracking it in 1997. Stable-value funds, which are considered less risky investments, experienced an 11 percent increase in asset allocation in 2008.

That’s why it might be wise for investors to get a fresh start with 401(k) advice as the economy improves. For existing investors or those who have never begun to save or invest for retirement, it might be time to consult both financial and tax experts such as a CERTIFIED FINANCIAL PLANNER™ professional to make sure both personal and work-related retirement savings complement each other.

Some recommendations to keep in mind:

Save even if your company fails to match: This is not the easiest thing to do, but even if your company cuts back on matching, it’s important to try and put additional money into personal retirement investments outside of work. You will still realize the benefit of pre-tax contributions made to your traditional 401(k). And, when you have money automatically taken from your paycheck you are “dollar cost averaging”. That means the fixed dollar amount that comes from your paycheck buys more shares when prices are low, and fewer when prices are high. Thus your average cost per share is lower than the average price per share.

Make sure you contribute to a plan: According to 2006 data from the Profit Sharing/401(k) Council of America, more than 22 percent of eligible workers don’t participate in available 401(k) plans. For the companies that are still matching, that’s like giving up free money.

Continue to save while you wait to join a plan: A significant number of companies don’t let you join the 401(k) until you’ve been working there a year. If that’s the case, get in the habit of putting money away for retirement anyway. Start an individual IRA with the funds you would put in the company plan, or set aside money in a savings account so you can supplement your cash flow and put the maximum amount into your 401(k) once you’re allowed to join.

Contribute the maximum: Not every employee can afford to contribute the maximum allowed by the plan, but try. In 2009, the maximum 401(k) contribution will be $16,500, and those older than 50 can make an additional catch-up contribution of $5,000.

Don’t let your company do all the work: More companies are automatically enrolling their workers in their 401(k) plans, but some workers fail to take charge afterward. They don’t know how much they’re allowed to contribute and they don’t discuss or review the types of investments they have in relation to their age or retirement plans. It might make sense to bring an outside investment advisor such as a CFP^® professional to review those choices with you.

Avoid poor diversification over time: It’s necessary to do a yearly checkup on all your retirement savings – 401(k) s, individual IRAs and other investments fueling your retirement goals to make sure you’re on track.

Don’t rely on the 401(k) alone: Particularly if matching lags for awhile, 401(k) plans can’t be relied upon as a single source of retirement dollars. You must invest outside your company plans.

Don’t over-invest in company stock: Most financial planners advise that you put no more than 15 to 20 percent of your whole 401(k) portfolio in company stock.

Don’t borrow from the 401(k): The Employee Benefit Research Institute® reports that employees contribute more to plans that let them borrow. Don’t be fooled. A 401(k) shouldn’t be a house fund or a source of emergency cash. You’re taking money out of the account that otherwise would grow tax-deferred, and if you fail to pay back the money, you could face income taxes and penalties. Instead, build an outside emergency fund of three to six months of living expenses you can draw from.

Don’t cash out: Some workers think it’s a great idea to treat a 401(k) as a windfall for when they quit a job. Don’t do it. You’ll pay huge penalties and lose your retirement savings momentum.

Don’t “lose” your old 401(k) accounts: Maybe you’ve changed jobs several times and never got around to moving older, smaller 401(k) accounts from past employers to current ones or into a self-directed retirement account. Always get advice about 401(k) funds when you leave an employer.

September 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V.Higgins, CFP, CLU, AEP, a local member of FPA.

• The IRS offers a 3-year window in 2010 to pay taxes on a Roth conversion.
• The IRS is letting tax payments on a conversion to be made in 2011 and 2012.
• Figuring out the tax due on a Roth conversion is not that complicated.If you have funds in an individual retirement account, converting them into a Roth IRA in 2010 presents an unprecedented opportunity to sock away tax-free retirement income.

The IRS is even offering taxpayers a three-year window in 2010 to pay taxes due on a conversion and is removing income limits that have kept higher-income taxpayers from setting up Roth IRAs.

Many taxpayers have been able to convert their traditional IRAs to Roth IRAs since Roth IRAs were created in 1998. However, income limits and other restrictions have kept many taxpayers from converting. If their modified gross income is more than $100,000, they haven’t been able to convert. But in 2010, they’ll get their first opportunity.

You don’t have to wait until then if your  modified adjusted gross income — your income minus certain deductions — is less than $100,000 and, if married, you file as “married filing jointly.” You could convert in 2009. However, to take advantage of special tax breaks offered only after Jan. 1, it may make sense to hold off, says Brent Lindell, a certified trust and financial adviser with Savant Capital Management in Rockford, Ill.

Roth IRAs differ from traditional IRAs in several crucial ways. While you don’t get a tax deduction for making a contribution to a Roth IRA, those contributions you may not have to pay any tax upon withdrawal in retirement. In addition, Roth IRAs aren’t subject to the same minimum distribution requirements that traditional IRAs are, so you don’t have to begin withdrawals from your Roth IRA at age 70½.

And because most retirement accounts took a heavy beating in the stock market in 2007 and 2008 and still haven’t recovered, the taxes due on a conversion are less than they would be had the market risen, making the case for conversion even more compelling, says Dave Sadler, a certified public accountant and Certified Financial Planner with Moneta Group, a wealth management firm in St. Louis.

If that’s not enough, the IRS is allowing taxpayers a one-time opportunity to spread out the payment of taxes due on a Roth conversion in 2010 over 2011 and 2012.

Taxes are due on a Roth conversion because you get a tax deduction on your initial contributions to most traditional IRAs, so you must pay the taxes due on those initial contributions and any growth in your IRA. Your tax bill on conversion also depends on a number of other factors, including your income, your federal tax bracket and your state tax rate.

Roth IRA conversions don’t make sense for everyone, but it’s worth investigating to decide whether it makes sense for you.

“The issue comes down to what your tax situation is in the year of conversion versus what it might be in retirement,” Sadler says.

“It’s a hard thing to know for sure, but I would say it makes the most sense for younger taxpayers who will have their income grow over time,” he says.

7 steps to a Roth IRA conversion

1. Evaluate your IRA and 401(k).
2. Seek advice if you’re unsure.
3. Weigh financial and tax factors.
4. Calculate the potential tax due.
5. Decide when to pay the tax bill.
6. Consider when to convert.
7. Fill out conversion paperwork.

Step 1: Evaluate your IRA and 401(k)

First, you need to get a handle on what assets you’ve got that are eligible for conversion into a Roth. Generally, any assets that you hold in a traditional IRA, whether they are deductible or nondeductible, are eligible. Nondeductible IRA contributions are not taxed when you make a conversion, although earnings from those contributions are taxed.

If you have a 401(k) or 403(b) from a former employer, you may want to roll them into an IRA this year so they will be eligible for rollover along with your other IRA assets. It’s a two-step process, first you roll over your old 401(k)s and 403(b)s into a traditional IRA. Then, you convert the traditional IRA to a Roth. That’s where the tax is due.

The higher the balance in your IRA or IRAs, the higher your tax bill will be if you convert. However, if you invested aggressively in the stock market and your account value is still down from two years ago, you won’t owe as much in taxes as you would have if the account total had been higher, Lindell says.

Under IRS rules, you have to consider the entire value of all of your IRAs when converting and figuring taxes on the conversion, if you have nondeductible IRA contributions.

“(In that instance,) even if you don’t want to convert the entire balance of all of your IRA accounts, whatever percentage you want to convert has to include assets from all of your IRA accounts,” Lindell says.

For example, if you have four traditional IRAs worth $100,000 and those accounts included nondeductible contributions, but you only want to convert $50,000 of those assets (all from one IRA), the IRS won’t allow you to convert only the assets that lost money. You have to take assets from all of your IRAs, not just the losing ones.

Step 2: Seek advice if you’re unsure

If you are considering conversion but are too confused to attempt it on your own, there are lots of places to find help, including the financial services firm that is the custodian of your IRA, or your tax professional or financial adviser.

If you don’t work with a tax professional, get a referral to a reputable local firm. Many offer consultations on these issues for free, says Jim Ciocia, a certified public accountant and chairman at Gilman Ciocia Inc., a tax and financial planning firm in Tampa, Fla. Make sure any advice you get is specific to your situation, he adds.

Step 3: Weigh financial and tax factors

For many taxpayers, the decision to convert is highly individual. How old you are and your present tax bracket all factor in.

“An important factor in deciding whether to convert is considering how much time you have before you retire and will potentially need to use the money,” Ciocia says.

The higher your tax bracket, the more tax you will have to pay on conversion. But if you expect taxes to go up in the long term, conversion makes sense because you may have to pay a higher tax rate in retirement than you expect now, Ciocia says. If you convert, you’ll have a tax-free source of retirement income along with any taxable source of income, such as a traditional IRA, 401(k) or 403(b).

As Ciocia puts it, “Would you rather pay taxes when you plant the seeds or harvest the crop?” In other words, you likely would pay less in taxes on a $5,000 Roth IRA contribution than you would if you had left the money in a traditional IRA and it grew to $34,242 after 25 years of tax-free growth at 8 percent.

In that example, even at a low 15 percent tax rate, your taxes would be $5,136.30 if you left the money in a traditional IRA — far higher than what you will pay now on a $5,000 conversion to a Roth.

Step 4: Calculate the potential tax due

Figuring out the tax due on conversion is not that complicated. Basically, you owe federal and state taxes on your contributions and any gains, meaning the entire value of your IRA, unless you made nondeductible contributions. If you made nondeductible contributions, you would subtract those from your current total IRA account balances to come up with the amount that will be taxed.

Here’s an example:

You’ll still get a break in when you pay your taxes. Using the above example, with $12,000 in federal taxes due, you wouldn’t have to pay any of that in 2010; you’ll owe $6,000 in 2011 and another $6,000 in 2012.

Step 5: Decide when to pay the tax bill

There are a few other issues to consider when deciding whether to pay the tax due immediately after conversion — if you can afford to — or defer it.

“Whether you want to pay the taxes in 2010 or spread it out over the next two years depends on how consistent your tax situation is,” Sadler says. “If you’re a W-2 employee and don’t have any capital gains or other types of holdings that might create surprises along the way, … you aren’t likely to see a huge tax increase. So I would think deferring those taxes over a two-year period would make sense.”

Many tax advisers agree that for a Roth conversion to make sense, you should be able to pay taxes from your income or another source, not from funds taken from your IRA.

“If you’re thinking about cashing in part of your IRA to pay the tax bill on it, forget it,” Savant Capital’s Lindell says. “You’re defeated already.”

That’s because you’ll have to pay interest and penalties on any IRA funds you remove from your account to pay taxes. Paying the taxes from your IRA account also will reduce your balance and your ultimate nest egg when you retire, he adds.

Step 6: Consider when to convert

The earliest you can convert if you want to take advantage of the two-year tax deferral is Jan. 1, 2010, if your income is currently over the $100,000 limit and/or you plan to file as “married, filing separately.” If your income isn’t over the limit and you can afford to pay the tax now, there’s no reason to wait, especially if your traditional IRA dropped in value. If it appreciates between now and Jan. 1, your taxes in conversion will be higher, says Ciocia of Gilman Ciocia.

For many taxpayers, it makes sense to convert as early in 2010 as possible to gain as much possible from the tax-free growth that a Roth offers. However, if you’re unsure of what your income will be and what tax bracket you’ll be in, it makes sense to wait until the second half of 2010 to get a better handle on the tax consequences, says Sadler.

And don’t forget, there are no income limits beginning in 2010. So if you wait to convert, you can do it regardless of your income.

Step 7: Fill out conversion paperwork

The conversion paperwork isn’t that complicated. If you have made nondeductible contributions to your IRA, you will need to know how much you contributed in nondeductible contributions, which you can find in your income tax forms on Form 8606, Nondeductible IRAs.

You’ll need to let the custodian of your IRA — the mutual fund, bank or other financial services company that holds your account — know certain information, including:

• How you want your converted assets invested.
• Whether you will pay the taxes due yourself or want the custodian to withhold the amount from the IRA’s assets to pay them.
• Who you want to name as a beneficiary to receive the money upon your death.

By Amy E. Buttell • Bankrate.com

Amy E. Buttell is a frequent contributor to Bankrate.com, Interest.com and Better Investing Magazine. From her home base in Erie, Pa., she is studying accounting and financial planning with the goal of earning the certified public accountant and certified financial planner designations.

Investing can be very emotional. When the market is up, people tend to pour their money in. When the market is down, many investors “take their money and run.” Talk about counterproductive. Regular investing—also called “dollar cost averaging”—instills discipline to the process. If you have $1,200 and invest it all at once, depending on where market prices go, you could be ecstatic if the shares bought at $10 suddenly go up to $14. But, you could be shell shocked if the price goes to $5 and become paralyzed into not investing again. Whether the market is at a high or a low—or anywhere in between—dollar cost averaging keeps you investing. Automatic investment plans, whether through your employer or one you set up, are an easy way for you to take advantage of dollar cost averaging.

Systematic investing does not assure a profit and does not protect against loss in declining markets. Investors should evaluate their long-term financial ability to participate in a systematic investment plan.

The latter part of 2007 and 2008 will likely be remembered by many as a time filled with great uncertainty and volatility in the global markets. But, remember, investing regularly is a smart way to hedge against uncertainty. Simply put, it’s not WHEN you invest, it’s WHAT you invest. Many investors know there are two phases of investing: accumulation and distribution—or loosely put: building up and using up. During the accumulation phase, the primary goal is to build up shares. In our chart, we show that if a hypothetical investor makes a lump sum investment of $1,200 at $10 per share, the investor would have 120 shares. If the investor opts to dollar cost average $100 per month for twelve months, the portfolio would have more shares—144. These may seem like small numbers, but if you build a retirement nest egg over decades, it could mean the difference between being able to sell 12,000 shares versus 14,400.

Dollar cost averaging works especially well in volatile times. Making investments in a fixed dollar amount at regular intervals buys more shares when prices are lower and fewer shares when prices rise. So, over time dollar cost averaging may lower the average price per share paid and can help smooth out the effects of volatility in a portfolio. In our example, the lump sum investor paid an average of $10 per share while the one who bought shares monthly paid closer to $9 per share. Dollar cost averaging isn’t just for novices—this shrewd portfolio-building method is great for seasoned investors as well.

Invest $1,200 All at Once or Over Time?
Regular Investing May Smooth the Ride

Past performance does not guarantee future results. This chart is shown for illustrative purposes only and is not intended to represent the performance of any Oppenheimer fund. Systematic investing does not assure a profi t and does not protect against loss in declining markets. Before investing, investors should evaluate their long-term financial ability to participate in such a plan.

Before investing in any of the Oppenheimer funds, investors should carefully consider a fund’s investment objectives, risks, charges and expenses. Fund prospectuses contain this and other information about the funds, and may be obtained by asking your financial advisor, visiting www.oppenheimerfunds.com or calling 1.800.525.7048. Read prospectuses carefully before investing.

At no time since the Great Depression have college students worried more about money. Tuition continues to rise, financing sources continue to contract. So why should a student worry about finding money for, of all things, retirement?

Because even a few dollars a week put toward a Roth IRA can reap enormous benefits over the 40-50 years of a career lifetime that today’s average college student will complete after graduation. Take the example of an 18-year-old who contributes $5,000 each year of school until she graduates. Assume that $20,000 grows at 7.5 percent a year until age 65 – that would mean more than a half million dollars from that initial four-year investment without adding another dime.

Consider what would happen if she added more.

There are a few considerations before a student starts to accumulate funds for the IRA. First, students should try and avoid or extinguish as much debt – particularly high-rate credit card debt – as possible. Then, it’s time to establish an emergency fund of 3-6 months of living expenses to make sure that a student can continue to afford the basics at school if an unexpected problem occurs.

Certainly $5,000 a year sounds like an enormous amount of outside money for today’s student to gather, but it’s not impossible. Here’s some information about Roth IRAs and ideas for students to find the money to fund them.

The basics of Roth IRAs: It’s good to start with describing the difference between a traditional IRA and a Roth IRA and why Roths might be a better choice for the average student. Traditional IRAs allow investors to save money tax-deferred with deductible contributions until they’re ready to begin withdrawals anytime between age 59 ½ and 70 ½. Roth IRAs don’t allow tax-deductible contributions, but they allow tax-free withdrawal of funds with no mandatory distribution age and allow these assets to pass to heirs tax-free as well. If someone leaves their savings in the Roth for at least five years and waits until they’re 59 1/2 to take withdrawals, they’ll never pay taxes on the gains. For someone in their late teens and early 20s, that offers the potential for significant earnings over decades with great tax consequences later.

Getting started is easy: Some banks, brokerages and mutual fund companies will let an investor open a Roth IRA for as little as $50 and $25 a month afterward. It’s a good idea to check around for the lowest minimum amounts that can get a student in the game so they can plan to increase those contributions as their income goes up over time. Also, some institutions offer cash bonuses for starting an account. Go with the best deal and start by putting that bonus right into the account.

It’s wise to get advice first: Every student’s financial situation is different. One of the best gifts a student can get is an early visit – accompanied by their parents – to a financial advisor such as a Certified Financial Planner™ professional. A planner trained in working with students can certainly talk about this IRA idea, but also provide a broader viewpoint on a student’s overall goals and challenges. While starting an early IRA is a great idea for everyone, students may also need to know how to find scholarships and grants and smart ideas for borrowing to stay in school. A good planner is a one-stop source of advice for all those issues unique to the student’s situation.

Plan to invest a set percentage from the student’s vacation, part-time or work/study paychecks: People who save in excess of 10 percent of their earnings are much better positioned for retirement than anyone else. Remarkably few people set that goal. One of the benefits of the IRA idea is it gets students committing early to the 10 percent figure every time they deposit a paycheck. It’s a habit that will help them build a good life.

Get relatives to contribute: If a student regularly gets gifts of money from relatives, it might not be a bad idea to mention the IRA idea to those relatives. Adults like to help kids who are smart with money, and if the student can commit to this savings plan rather than blowing it at the mall, they might feel considerably better about the money they give away. At a minimum, the student should earmark a set amount of “found” money like birthday and holiday gift money toward a Roth IRA in excess of the 10 percent figure.

August 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V. Higgins, CFP, CLU, AEP, a local member of FPA.

With so much cash on the sidelines, Certificates of Deposit (CDs) can be alluring in
today’s market. The interest rate is likely better than most savings accounts and CDs
are insured by the FDIC (Federal Insurance Deposit Corporation) up to $250,000.
This combination is attractive to investors looking to reduce the risk of potential
short-term losses in the stock market.

Before you invest in a CD make sure you understand the potential pitfalls. CDs may
lock you in at a low interest rate. The chart shows as of March 31, 2009 the national
average on a six-month CD was about 1%. Additionally, an early withdrawal penalty
is typically charged if you want access to your money before a CD matures. Lastly,
make sure you also understand the “real return” on a CD, which means how taxes
and inflation may erode what you’ll take home. Indeed, the chart shows CD holders
frequently suffered negative real returns over the past decade.

Is there a place for CDs in an investor’s portfolio? Yes, as short-term investments
that act as a base of a diversified portfolio. But you should keep in mind that a
portfolio needs to include other investments as well that have the potential to keep
pace with inflation and taxes to help you achieve your long-term financial goals.

Fixed income investing entails credit risks and interest rate risks. When interest rates rise, bond prices generally fall, and the Fund’s share prices can fall. Lower rated “junk” bonds are more at risk of default than other bond investments and are subject to liquidity risk. Value investing involves the risk that the market may not recognize that the securities are undervalued and they may not appreciate as anticipated. Foreign investments may be more volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic factors. Growth and technology investments may be especially volatile. Diversification does not guarantee profit or protect against loss.

Source of chart data: Ned Davis Research, 3/31/09. Inflation rates are represented by the change in the Consumer Price Index (CPI) and CD Rates are six-month certificates of deposit rates as tracked by an average of dealer offering rates on nationally traded Certificates of Deposit. Returns are net of 28% federal income tax rate. Real rate of return is equal to (CD rate minus inflation rate) minus (CD Rate x Tax rate). This chart is for illustrative purposes only and does not predict or depict the performance of any particular investment.

Shares of Oppenheimer funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including the possible loss of the principal amount invested. Before investing in any of the Oppenheimer funds, investors should carefully consider a fund’s investment objectives, risks, charges and expenses. Fund prospectuses contain this and other information about the funds, and may be obtained by asking your financial advisor, visiting www.oppenheimerfunds.com or calling 1.800.525.7048. Read prospectuses carefully before investing.

An old and particularly annoying Wall Street adage holds that “a bull market climbs a wall of worry.” It’s nettlesome for a couple of reasons: (a) it’s undeniably true, but (b) it still doesn’t tell you when or even if your worry is misplaced.Perhaps you’ll prefer the late John Templeton’s more elegant (and more complete) formulation: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Any way you state it, this fundamental truism suggests that markets often go up quite a bit when many or most people are still firmly convinced that they have no business doing anything of the kind.

The plain fact is that it’s easy to be pessimistic when the economic data are dreadful and the market is falling. A crashing economy feeding the flames of a crashing market just feels right to most people. Regardless of what we end up deciding to do (or refrain from doing) with our portfolios in response to the bad economy/bad market feedback loop, at least we feel that we understand what’s going on.

It’s when the economy and the market seem to be seriously diverging that our anxiety levels start rising again. At such times, it’s not just that we don’t know what to do. It’s that what’s going on doesn’t seem to make any sense. This summer, investors may very well feel themselves to be in just such a pickle.

Gross domestic product is—or certainly was at last report—still falling. Despite massive federal stimulus that has no precedent by any measure since World War II, unemployment continues not just to rise but to soar. States are teetering on the brink of insolvency; California was recently paying its bills with IOUs. Home foreclosures are still rising, and home prices still falling. Even though a couple of the more successful banks have noisily repaid their TARP money, the banking system as a whole remains on life support.

Two of the three major auto makers have gone bankrupt; they are now largely owned by the government and their unions, and have thus transferred their huge unfunded pension liabilities to the taxpayers—who are also, through the nationalization of Fannie Mae and Freddie Mac, on the hook for the vast preponderance of the shaky mortgage debt in this country. And, oh yes, we have recently been giving very serious consideration to nationalizing health care in some form or fashion, with deficit and tax consequences no one seems to be able authoritatively to quantify.

All of this would make perfect (and perfectly awful) sense, except for one very bothersome fact. To wit, the stock market, at this writing in late July, is soaring. And that’s the verb, friends: soaring. It’s not rallying, it’s not recovering, it’s not creeping back. Up 44% (on a closing basis) in a heck of a lot less than five months? Excuse me: that’s soaring, or else there’s no such thing. There is surely a wall of things legitimately to worry about. And this market is certainly doing a bang-up job of climbing it.

People who rode out the horrific market decline of 2007–09—because we knew from bitter experience that we didn’t know where to get out, and would never know where to get back in, so we might as well just stay put—may regard this apparent contradiction with a certain amount of bemused detachment. (We paid in blood for that luxury, and you’d better believe we’re going to enjoy it.)

But the bad economy/rising market dichotomy can only be of very pressing concern to people who either removed their long-term investment capital from equities during the decline, or who have been holding back considerable new money—money which must at some point be committed to equities—waiting for some clear signal that the economy has meaningfully (and lastingly) turned. That’s historically the problem with either getting out of, or standing back from, a falling market: you get to be gratifyingly right for a relatively little while (in the context of an investing lifetime), but then you’re under the gun to be right a second time, with regard to getting back in.

The psychological pressure of that second decision is compounded, of course, by the largely self-imposed burden of regret at having “missed it.” How can I get back in the 970s on the S&P (this line of thinking runs) when I didn’t in the 670s…or the 770s…or the 870s…even when I kept reading that things might still be bad, but that they didn’t seem to be quite as bad as they were back when snow was on the ground. With my luck, I’ll get back in here in the 970s, and it’ll go right back down again…

This is a formula for paralysis. The way to break out of it—with the empathetic coaching of your financial advisor—is to begin thinking of the problem not in terms of the market but in terms of your goals. If you’re like most of us, money market yields are not going to get you where you need to go. They’re probably not going to be enough to secure a long retirement full of dignity and independence; they’re probably not going to get your granddaughter through college; they’re probably not going to keep your mother in a decent nursing facility, and they’re probably not going to fund meaningful legacies to the people you love and must leave behind in the world.

Try to formulate the problem as follows: every day you stay in cash at money market rates of interest is probably a day when you get further from, rather than closer to, the ability to fund your most cherished financial goals. Accepting that stark realization, rather than remaining mired in the bottomless anxiety of when and where to get back in the market, may—if you let it—move you toward a sensible long-term investment decision.

Warren Buffett, perhaps the greatest equity investor who ever lived, said, “The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.”

He said that in the issue of Forbes magazine dated August 6, 1979—just about thirty years to the day before you’ll be reading this. It may interest you—and, much more to the point, it may help you more comfortably to reach a good decision—to learn that on that day the S&P 500 closed at 104.

© 2009 Nick Murray. All rights reserved. Used by permission.

After a marriage breaks up, about the last thing most people want to do is sit down with one more attorney. But no matter how old you are or whether you have kids, it’s important to consult both financial and legal experts to make sure you have an updated estate and financial plan for your new life once the divorce decree is final.

It’s also best to blend estate planning with financial planning post-divorce. If you weren’t working with a financial or estate planner during the divorce process, it’s time to do so now. The immediate months after a divorce can be disorienting – even if you don’t move, you are literally starting a new household that you will have to direct yourself, and that means new money issues to face.

This is why that the weeks immediately after a divorce are a good time to revisit short- and long-term spending and planning goals. Here’s a general road map to that process:

Start with a financial planner: Whether you plan to stay single, remarry or move in with a new partner, it’s good to get a baseline look at your finances as early as possible after the divorce is final.  Expenses for the newly single can pile up quickly and unexpectedly, and a financial planning professional can help you review your new current spending and savings needs, compare strategies to achieve long-term goals like college and retirement and give you critical tools to protect your assets and loved ones if you die suddenly. Even if you have a good relationship with an ex-spouse and you addressed key issues for your children as part of the divorce proceedings, you need to revisit all these issues as a single individual before you move on to the next stage.

Talk with a trained estate planning attorney about wills and other critical documents: True, there are software programs and other kit solutions available to write basic wills, powers of attorney and certain simple trust agreements. But it makes sense to coordinate the activities of a financial planner with an estate planning attorney who can tailor an overall estate plan specific to your needs no matter how basic they might be right now. Even if you are very young with few assets, it makes sense to get some solid advice in this area so you’ll be able to manage such planning as you age and your finances get more complex. Particularly if you have kids, such planning is important if you plan to remarry and if you want to guarantee that specific assets are guaranteed for them when you die.  In some cases where a spouse dies unmarried with minor children, an ex-spouse might automatically gain control of assets that were supposed to be earmarked for the kids. If you don’t want that to happen, you need to plan for that legally.

Make a guardianship game plan for your kids: It’s not enough to plan how money and assets will go to your children if you or your ex-spouse die suddenly or are incapacitated.  If your children are minors, it’s particularly important to make sure you and your ex-spouse have a guardianship plan for their upbringing as well as any assets they may inherit. You might completely trust your ex-spouse’s new husband, wife or partner to raise your kids if your ex-spouse dies before you, but there may be others better-equipped to do so – spell that out now.  Also, if there are any trust or wealth issues that will become effective for your children once they reach adulthood, it’s also important to establish an efficient legal structure for distributing those assets as well as appointing a trustee in a will to train and guide your kids through that financial transition.

Plan for special needs kids: If one of your children is disabled and is expected to need lifetime assistance of some type, then you should consult a qualified attorney to help you create a special needs trust. It will help protect your child from having to give up any public or social financial assistance as well as access to special doctors, medical help, special prescriptions or treatments that could be taken away if they were to personally inherit assets that would disqualify them for these programs. When such assets are held in trust, they are not counted as the child’s assets. The advantage is that those inherited assets may still be used to support their housing or other personal living needs.

Get solid protection in place: Most people focus on what may happen to their health insurance if they get divorced, but insurance issues like life, property/casualty and disability insurance are sometimes put on the back burner.  If you’re newly single, you definitely need the best health coverage you can afford for yourself and your kids, but life, property, liability and disability insurance becomes doubly important, particularly if you failed to address those needs during the divorce.  Even if your ex-spouse is cooperative with financial support, it’s wise to insure yourself as if they weren’t. A financial planner should be able to go through those options in detail.

Review all your investments for primary ownership and beneficiary information: Even if you were advised correctly to change the names on assets you and your spouse were dividing between yourselves, it still makes sense post-divorce to review that the names are indeed correct on those assets, and most important, to make sure all beneficiary information is correct.

June 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP,CLU,AEP, a local member of FPA.