Belfast, Maine -- It's hard to believe, sitting here at a cottage window, that the world is having its daily crisis, that billions are being lost, that oil prices are yet higher, and it is all the subject of important -- no, pressing -- chatter on the Internet.

Here, life just goes on, paced by blooming lupines, the scent of freshly mowed grass and the distant sound of seagulls. From our windows I see the quaint little cottages of Bayside in one direction and a brisk sweep down Penobscot Bay in another. It occurs to me, however, that Maine weather is a bit like the stock market -- moments of crystalline exuberance followed by days, weeks, or maybe forever, of unrelenting fog.

It would be really easy for me to trot out yet another story of real estate misery. From Boothbay Harbor to Stockton Springs, the landscape seems to have sprouted an overflow crop of "For Sale" signs. Asking prices have come down, but they are still well over what people who actually work for a living can afford. One resident observes that we might see more signs, if many sellers hadn't taken their houses off the market.

But I will spare you that story. There is also a more positive, if subtle, message here. It is this. Some people would have us focus on loss. We in media-land excel at that.

But if we focus on loss, we'll miss seeing the things that are not lost, but restored. We'll also miss the things that are reinvented, rather than restored. Here are two examples, both from this little stretch of Midcoast Maine.

Reinvention.

On Thursday, June 19, the Republican Journal, the weekly paper of Belfast, announced that it and five other weekly newspapers in the Midcoast area were being purchased by Village Net Media Inc., an affiliate of www.villagesoup.com. The goal will be to weave together the Internet platform of Village Soup with the print circulation of small newspapers that can trace their history back well over a century. The Belfast Republican Journal, for instance, began publication in 1829.

This is the technology version of your basic man-bites-dog story.

Small newspapers have been threatened with extinction before. In the late '60s small newspapers were dying because of costs, primarily the incredible burden of setting hot type. Then Boston inventor William Garth invented a small and inexpensive photo-typesetting machine. A small newspaper could switch to photo-typesetting for an investment of about $5,000 in one of the machines Mr. Garth's company, Compugraphic, manufactured. Later, linking computers to photo-typesetters eliminated redundant key-boarding and improved the economics of small papers still more.

Through the '70s and '80s there was much media hand-wringing over the decline of newspaper circulations. The decline, however, was limited to major metropolitan papers because small weeklies and dailies were enjoying healthy circulation increases.

Will Village Soup-like changes slow or stop the current decline of traditional newspapers? I don't know. Recently, major newspaper stocks like The Washington Post, New York Times and Gannett were off 26 percent, 38 percent and 59 percent, respectively, over the last 12 months. The stock market is predicting a quick death.

This may be a lousy time to own the shares of legacy newspaper companies, but it's a great time for communication between human beings. Never has so much been possible, so easily. Reinvention trumps loss.

Restoration.

Three days later, a Belfast boat builder, French and Webb, launched three magnificently restored Buzzards Bay 30s from the town boat ramp, amidst the cheers of nearly a thousand people. These lovely N.G. Herreshoff designs were first built in 1910. They represent artful skills that are rapidly being lost. But master boat builders like French and Webb are keeping those skills alive.

Few can afford these works of art -- my brother and I joked that our shared 1980 J30 sloop probably cost less than the last round of varnish work done on any one of these boats -- but it is still a thrill to see the best of an era, to see both exquisite workmanship and appreciation for what has gone before.

As for the stock market, I don't mean to sound cavalier but, well, it's only money. It only dimly represents what we can do.

ON THE WEB

Q. Which would be safest and offer the best long-term results for my 401(k) --- a stable value fund or an inflation-protected bond fund?
---O.C., by email

A. Go for the inflation-protected bond fund. Long term, it will provide you with a small premium (probably something over 1 percentage point) over the inflation rate. With the CPI running year-over-year annual increases just over 4 percent so far this year, investments like stable value funds and guaranteed investment contracts (GICs) are hard-pressed just to match the inflation rate.

Q. I am looking at rolling my 401(k) into an IRA. I am also considering turning it into a Roth IRA because of my concerns about future income tax rates. What would be the best way for me to examine the two options? What assumptions do I need to make? I know that I would get an early withdrawal penalty, and I have a little more than $5,500. I have considered putting either the IRA or Roth IRA into a few ETFs since I have a long time to let my money work--- I am 28. What advice do you have for me?---B. W., by email

A. Why pay a penalty when you can do an IRA rollover to a Roth IRA conversion? Provided your income is not too high to allow it, you should be able to convert simply by paying taxes. You can maximize the value of the Roth IRA conversion by paying the taxes from a source outside the IRA rollover.

For someone your age, converting to a Roth is a very good idea. First, your current tax rate is probably relatively low, so the cost of conversion won’t be punitive. Second, even if future tax rates aren’t higher, the money you put into a Roth IRA won’t engage the taxation of Social Security benefits. Benefits will be taxed for most workers your age because the formula for the taxation of Social Security benefits is not indexed for inflation. You can thank the political weasels of both parties for that. They passed the tax in 1983, knowing they would be long gone when it really began to bite.

Q. My wife and I are considering building our dream home on our dream lot here in East Texas. I am 60, employed and plan to work 5 more years (salary $64,000). My wife is 57 and plans to work until 63-65 (salary $50,000). We owe $45,000 on our lot.

We plan to sell our current home in 2009 and hope to clear about $140,000. We will then rent until our new home is built. We anticipate the total cost of the home and lot to be about $305,000. We plan to put down $100,000 and finance the balance for about 3-4 years. When I retire, we will be able to access the $250,000 in my 401(k). At that time, we will pay off the remaining mortgage with proceeds from the 401(k).

Our retirement income is my pension of about $1,800 a month, my wife's pension of about $2,300/month, and my Social Security of about $1,500/month. Since my wife is in the teacher retirement system, she is not allowed to draw my Social Security after my death but will receive my full pension. We have savings of about $35,000, and she has an annuity that will be worth about $25,000 when she retires. Do you think this is a workable plan, or is it too risky? ---J. E., by email

A. Your plan could work, but unless there is very strong growth of your 401(k) plan assets, it is likely to leave you “house poor” and with minimal flexibility. Here’s why.

Basically, you’re talking about doubling the operating expense of your shelter just as your income is cut by about 40 percent. Similarly, paying off the mortgage will make a major dent in your financial assets, leaving you with limited flexibility. Worse, every dime you take from your 401(k) to pay off the mortgage will likely put you in a high tax bracket.

While you and your wife have the security of two pensions, unless those pensions are indexed to inflation (most aren’t), you’ll start retirement pinched for spending money and it will quickly get worse as inflation reduces the purchasing power those pensions provide.

Most retirees should be trying to go in the opposite direction, scaling back their shelter to liberate their equity and increase their income.

Allow me to introduce the Power of Non-Financial Thinking. This is the kind of thinking that actual people can do. It involves none of the magical thinking preferred by those on Wall Street who make their living selling us the next financial cure-all. It also acknowledges something the financial services industry doesn’t want us to know.

When push comes to shove, investments rank third or fourth when it comes to measuring the retirement security of 9 out of 10 Americans.

I’m not saying investments aren’t important. They’re just not as important as two or three other things--- Social Security, home equity and pensions for the small crew that still has them.

To illustrate, let’s consider the case of Mad Max and his wife, Molly. He’s nearly 66, married, and earns an interesting amount--- $102,000 a year. The amount is interesting because it is the top of the Social Security wage base this year. Only 6 percent of all workers earn more. Max has accumulated about $600,000 in his company 401(k) plan, and they’ve just made the last mortgage payment on a house now worth about $400,000.

Mad Max and Molly are well-off by most standards. They have a net worth of $1 million and high Social Security benefits. Mad Max will be eligible, this year, to take benefits of $2,185 a month, or $26,220 a year. His wife, who is the same age, will be eligible for $13,110 in spousal benefits, giving them total benefits of $39,330 a year. Their retirement income will be their benefits, their investment income, and the invisible income they get from home equity. (It’s in shelter services, not cash, which means it isn’t taxable. Their standard of living will be higher than a young couple next door who have the same cash income but make payments on a large mortgage.)

How can Mad and Molly increase their spending power?

They have three big levers: cutting investment fees, delaying Social Security, and downsizing their house. All three levers can be pulled with zero insight into what Ben Bernanke is thinking, what the price of oil will be next week or next year, who will be elected president in November, or whether interest rates (stocks, the dollar, etc.) will rise or fall.

Even more important, the three big levers aren’t bets. They are certainties.

Lever No.1: Cut investment expenses.

This is easy to do, and today, more than ever, Wall Street and its products deserve to be shunned. Rather than pay 2 percent, or more, in annual investment fees to have only a 30 percent chance of beating market returns, cut your expenses. Opt for less expensive investments such as my Couch Potato Building Block index portfolios or a small number of low-cost balanced funds. This will allow you to stop sharing your retirement income with the flashy strangers who brought us the subprime crisis.

What’s it worth to you? About 1.5 percent of your investments a year, maybe more. Mad and Molly, for instance, draw 6 percent from their investments before fees of 2 percent. That nets them $24,000 a year. By cutting out the legacy distribution system, they can draw 6 percent before fees of 0.5 percent a year. So the same draw on their money will net them $33,000. That’s a one-decision income increase of $9,000. To get that from their legacy distribution system vendor, they’d need to add $225,000 to their account.

Lever No. 2: Delay taking Social Security benefits.

Every year that Mad Max delays taking benefits, he forgoes $26,220 of income, but his benefits will increase by 8 percent for the rest of his life (and his wife’s, if she survives him). That $2,097-a-year tax-free increase would cost $42,627 if it was purchased as an inflation-adjusted life annuity. So even if he has to draw down his financial assets, he’s trading $26,220 for another asset worth 60 percent more.

Lever No. 3: Downsize your Shelter.

Mad Max and Molly love their home, but it costs about $16,000 a year to pay the taxes, insurance, utilities and maintenance costs. Sometimes it costs more. If they sold and reinvested in a house that cost half as much, their operating expenses would go down to about $8,000, and the $200,000 of equity they had to reinvest like their other financial assets would earn $11,000 after reduced fees but before taxes. It might net $9,350--- more than enough to pay the operating expenses on their smaller house. That’s a spending gain, after taxes, of $17,350 a year.

Each of these levers is a sure thing. Not the phony hints of astounding profit opportunities from Wall Street.

On the web:

Q. Can I be said to be a millionaire? I have cash-type assets of about $180,000. I have a 401(k) worth about $82,000. My paid-off home is worth about $175,000. I will also receive a defined-benefit pension. I could receive it (retire from service) about five years from now, when I will be 53 years old. My annual statement gives the currently projected "lifetime annuity value" as about $1.515 million. I believe it is based on a $4,520 monthly benefit over my estimated lifetime (53 years to 81 years of age). A rough calculation of present value says this is worth about $570,000. That, plus the above assets, gives a total right at $1 million. ---D.J., by email from Dallas, TX

A. It would be safer to say you are a “virtual millionaire.” The value of your monthly pension is the sum of money, invested today, that would produce the guaranteed monthly income for the rest of your life. You can check that by visiting www.immediateannuities.com, entering your age, state of residence, and expected monthly income. It will show you how much that income would cost as an investment in a single premium immediate annuity. The value will depend on your marital status, whether there is a guarantee period, and the level of survivor benefits to your spouse if you are married.

It is quite likely that the combination of your pension and Social Security benefits makes you a millionaire entirely in virtual assets. Of course, if you counted millionaires this way, they’d be a dime a dozen.

Few realize it, but it costs a great deal to buy a single premium inflation-adjusted life annuity. That’s what Social Security provides. Generally, they cost about 50 percent more than a conventional fixed annuity.

Let me give you an example, using quotes for a Vanguard inflation-adjusted life annuity. Suppose you are an average worker retiring with a Social Security benefit of about $1,100 a month. Since your spouse may receive that benefit as a widow upon your death, it is likely that one or both of you will receive that benefit for about 25 years. The value of that income stream is a virtual $264,289. (You can get quotes at http://www.aigretirementgold.com/vlip/VLIPController?page=RequestaQuote.) In addition, your spouse also receives benefits.

These benefits would be valued based on your individual life expectancy. The total is the virtual value of Social Security for a couple. Add the value of Medicare benefits, and many Americans are virtual millionaires on the basis of their Social Security and Medicare benefits alone.

Why am I telling you all this?

Simple. The financial services industry routinely emphasizes our savings--- our financial assets. Putting primary attention to these assets is appropriate for the top 5 or 10 percent of all households. But for the other 90 percent, the big levers are Social Security, a pension, if you have one, and home equity. For most people, financial assets are a distant fourth.

This reality means that true financial planning involves more attention to benefits and homeownership. And less attention to saving and financial assets. Indeed, in my new book with economist Laurence J. Kotlikoff, “Spend ‘til the End,” we don’t get to managing financial assets until page 236 of a 300 page book.

Q. Part of my income comes from interest. With CD rates so low, I am looking at municipal tax-free bonds for higher rates. I am considering only AAA-rated bonds that are insured. Are they safe? Do the ratings and insurance really mean they are safe? I have heard that the rating system needs to be reviewed to make it more meaningful.---W.B., by email

A. Buying municipal bonds isn’t a fruitful activity for most people, most of the time. The reason for this is simple: The tax-free yield is usually less than a comparable taxable yield security by an amount equal to or greater than your tax bracket. So there is little or no spendable advantage--- unless you are in a very high tax bracket.

But now isn’t “usually” or “most of the time.”

Recently, 5-year-maturity AAA munis were priced to yield 3.25 percent, while the national average on taxable 5-year CDs was only 3.48 percent. If you file a tax return and pay taxes, you’d be slightly better off in the AAA munis! If you are in the 25 percent or higher tax bracket, buying munis will make a real difference in your income.

Given the financial condition of the firms that insure municipal bonds, you should prefer uninsured but AAA-rated bonds over insured bonds.

Downsizing may be the best retirement decision millions of boomers can make. It’s relatively easy to do. And, as you’ll soon see, the lifetime benefits can be enormous.

But first, meet John and Jane Bighouse. They’re about to downsize. He’s 64. She’s 62. He earns $100,000 a year as a project manager, and Jane hopes to make $30,000 this year as a Realtor. They live well and, like many couples, finally got to buy their dream house ten years ago.

That’s when the last tuition bill was paid, the kids were off the payroll, and the dog died. John and Jane regularly joke about how weird it is that they now live in a 3,000-square-foot house, but they raised two kids in a 2,000-square-foot house. Their decision isn’t unique. A legion of advertisers sees empty nesters as the mother lode of discretionary income for travel, upscale products, home improvements, second homes, boats, and expensive cars.

So when the Bighouses had an opportunity to save big time, they opted instead for a larger house and a designer kitchen with granite countertops. It seemed like a good idea at the time.

Now they have a problem.

John is pretty sure his job will disappear next year. Showing cautious couples dozens of houses to make a sale is starting to wear Jane down. Both are thinking 2009 may be the year to retire, ready or not.

Not.

John has $200,000 in his company 401(k) plan. They’ve also got $10,000 in their checking account and $100,000 of mutual funds in taxable accounts. Most of their net worth is tied up in their home, now worth $800,000. That’s double the $400,000 purchase price ten years ago and only $250,000 remains on their 6 percent mortgage, with a monthly payment of $1,800. No one would consider them poor, but they are heading for a major drop in their standard of living.

Using ESPlanner software, the lifetime security planning software that I’ve mentioned in many earlier columns, John learns that their total income in 2009 will be $39,000. While it will rise to a maximum of $56,000 (in constant dollars) in a few years, that’s a gigantic drop from the $130,000 they’ll earn this year.

More than half of that $39,000 of income will come from his Social Security benefits of $21,565. Jane will start collecting benefits of $10,590 on his work record, but not until 2011 when she is 65. Assuming a 7.5 percent return on their investments and a 4 percent inflation rate, ESPlanner finds they can sustain a real, inflation-adjusted consumption of $18,536 a year for as long as they live as a couple. Jane will have the same equivalent amount in the years she is likely to be a widow.

This $18,536 a year is what they will have left to spend on themselves after they have paid their income taxes, housing expenses and Medicare premiums.

John thinks it will be difficult to get along on $18,536 a year. So does Jane.

Then Jane has a flash of insight. “John, if we raised two kids in 2,000 square feet, maybe we can retire in less than 3,000 square feet.”

“Are you suggesting we give up his and hers closets?”

“Yes. If we eliminated all the clothes we never wear, we’d only need about half a closet.”

“Do you have any particular size house in mind?” John asked.

"I’m thinking condo or townhouse. I’m thinking two bedrooms, two and a half baths, and about 1,200 square feet, 1,500 tops. That’s the space we can live in. We don’t need to keep the Perpetual Kid bedrooms. And if we lived in a smaller place I could, finally, get out of cooking Thanksgiving dinner.”

“How much do you think that might cost?”

“Let’s try $250,000.”

When they enter those changes into the program, they get a very pleasant surprise. The combination of selling to buy a smaller house, not having a mortgage, and increasing the taxable investment portfolio more than doubles their lifetime consumption. Instead of having to live on $18,536 a year, they’ll have $40,027 to spend on things beyond taxes, shelter and Medicare.

There are other decisions they can make, such as his delaying taking Social Security benefits, but few will increase their effective standard of living as much as downsizing. Other couples who are house rich and investment poor may have more, or less, dramatic results, but few would suffer from downsizing.

On the web:

Q. I have around $1.2 million, mostly in equities. My house is paid for.  There will be around $300,000 in company profit sharing when I retire, and that has been my ace in the hole for the conservative portion of my investments.  If I were to retire soon, what would you advise doing with the $300,000? - J.C., by email from North Arlington, TX

A. With a $1.5 million nest egg, your starting withdrawal rate should be between 4 percent and 5 percent, preferably 4 percent if you are retiring under age 65. That’s $60,000 a year.

One way to prepare for retirement at any time is to build a ladder of fixed-income securities that will mature in 1,2,3,4,and 5 years. As each security matures, replace it with a new 5-year security. That way, you know you’ll have 5 years of withdrawals “banked,” and you won’t need to touch your equity investments for that long. Most market declines last only a year or two. The 2000-2002 decline was a relatively rare 3-year decline.

The ladder approach, by the way, is also a good defense against uncertain interest rates. Yields are now so low that making long-term commitments is dangerous. But with a 5-year ladder you’ll have an average maturity of about 2.5 years.

As I write this, Bloomberg.com indicates that the yield on a 5-year Treasury is 2.87 percent, while the yield on a 2-year Treasury is 2.04 percent and the yield on a 6-month T bill is only 1.53 percent. Basically, you’ll earn twice as much as a money market fund with very little increase in risk, particularly since you are never more than 12 months away from a maturity.

Although building a ladder involves some effort (first creating it, and then replacing the maturing security each year), it allows you to distinguish between market risk and what might be called “life risk”--- the risk of bad events in your life.

If you own a short-term, fixed-income mutual fund, you’ll always be subject to market risk--- the possibility that interest rates will increase and reduce the market value of the mutual fund portfolio. If you create a fixed-income ladder, on the other hand, you may never need to sell an individual security at a depressed value because a security is always about to mature at par value. Even if you have an extreme need for cash, your risk is reduced because you can sell the shortest maturity, the next shortest security, etc. If you find yourself in a situation that requires liquidating the entire ladder, the threat that you are facing will dwarf any issue of financial loss.

Q. I have a variable annuity with Vanguard valued at $370,000 with a cost basis of $110,000. It is in my living trust. At my death I have instructed that it be gifted to my charitable remainder trust, which will be used as a foundation for qualified Native American education.

Could I make partial gifts each year now (less my cost basis) and avoid taxes by balancing the yearly gift level to my annual income taxes? My 2007 1040 tax bill was about $3,500. ---B. K., by email from Dallas, TX

A. Sorry, that won’t reduce your current tax bill. When you withdraw money from a variable annuity, it is taken out on a last-in/first-out basis. That means you’ll take out $260,000 of taxable income before you get to take out non-taxable original principal. So if you withdrew, say, $30,000 for charitable gifts, that amount would be added to your taxable income.
You can avoid paying any taxes on the withdrawn amount by making a $30,000 contribution in the same year. Basically it will be a wash.

There are two important caveats here. First, your itemized deductions need to exceed the standard deduction BEFORE you make the charitable contribution. Otherwise, some portion of the charitable contribution won’t benefit from an offsetting tax deduction. Second, depending on how much other income you are spending, your charitable gift is likely to trigger the taxation of some Social Security benefits.

This is the kind of move you make AFTER you spend some time with a tax accountant.

Medicare premiums may soon start crushing retiree spending power. I estimate that many a long-lived couple may need to reduce their retirement spending on non-medical consumption by 13 percent to 26 percent to avoid sharp declines in purchasing power as they get older.

This is not an alarmist fantasy. My estimates come from projecting historical cost rates into the 30-year retirement of a couple retiring this year.

Here are the basic facts. Since 1965, the year Medicare was created, the consumer price index has risen at a 4.5 percent annual rate. But the Medicare premium has inflated at an 8.4 percent rate over the same period. Worse, the gap appears to be growing.

Between 2000 and 2008 the monthly Medicare premium grew from $45.40 to $96.40. That’s a 9.9 percent annual rate of increase. During the same eight-year period the consumer price index rose at only 2.8 percent a year. So Medicare costs are now rising 7 percent a year faster than the general inflation rate.

You can understand what this means for real people by considering the future of an imaginary couple, Mr. and Mrs. Retirenow.

They both turned 65 in January. They have $10,000 in cash, $300,000 in IRA investments, and they own their $200,000 home in Texas, free and clear. He collects $1,200 a month in Social Security, slightly above average. She collects $600 a month in spousal benefits. Neither has a pension, but they think they can get along pretty well on $21,600 in Social Security benefits and $15,000 from their IRA accounts, a total of $36,600 a year.

They feel pretty safe about that $15,000 a year from their investments because they found they would get that much if they purchased an inflation-adjusted joint life annuity from Vanguard. They’ll leave the house to the kids, but nothing else.

Another reason they feel positive about their retirement is that they live in a no-income-tax state. They also don’t owe anything in federal income taxes. Finally, we’re going to assume that they earn 7 percent on their investments and that inflation runs at 4 percent a year--- a little less than it has been since they were in their early 20s and started working.

Just weeks before they retired, they figured they would spend $2,314 of their $36,600 income on Medicare Part B premiums and $8,200 paying the insurance, taxes, and operating expenses of their house. That would leave them with $26,086 to spend on everything else.

To be sure, they’d never be candidates for Lifestyles of the Hideously Rich and Notorious but, well, who cares?
In fact, their lifetime spending will be lower. While a portion of the reduction will come from a slowly increasing federal income tax bill, most of the reduction will be due to rising Medicare Part B premiums.

To find out how much lower, I used ESPlanner, the most powerful and comprehensive financial planning software available today. It’s also the foundation for “Spend ‘til the End” (Simon and Schuster, $26) the recently published book on financial planning I coauthored with Boston University economist Laurence J. Kotlikoff. ESPlanner, which I’ve mentioned in many columns, uses dynamic programming to actually solve the question most retirees ask:

How much can I spend and have a level standard of living for the rest of my life?

ESPlanner tells us that the Retirenows would have $24,460 a year to spend until they died at age 95, if Medicare premiums rose only at the general inflation rate. But with a long-term premium increase that’s nearly 4 percent higher, their spending power drops to $22,809. And if Medicare inflation continues to run 7 percent faster than inflation, their spending power drops to $21,289 a year, a reduction of 13 percent.

Since the growth of Medicare Part B premiums is likely to be paralleled by the growth of premiums for Medigap policies (which often cost about as much as the Part B premium), the lifetime loss of living standard over a long retirement is likely to be about 26 percent.

How will younger people who retire in the future be affected?

Sadly, the younger you are, the greater the impact of rising Medicare premiums because the premium is rising faster than both wages and Social Security benefits.

On the web:

Q. My wife and I are nearing retirement, maximum two years away. In his recent letter to stockholders, Warren Buffett said that investment returns from 1901 to 1999 averaged 5.3 percent plus 2 percent additional for dividends. He described this time period as a very good century.

He also said that if expectations are that investment returns for the next 100 years will match the previous 100 years, then the Dow would have to close at around 2 million in 2099. He said many investment advisers talk about 10 percent or better returns to their clients. If investors expect 10 percent, then the Dow would have to close at 24 million in 2099. He also is very suspicious of pension plans that are based on an average of about 8 percent compounded returns.

I guess what I’m asking is--- should we find the safest, highest-yielding corporate, Treasury or municipal bonds that we can find, or do you think the stock market is still a good bet for retired people? How should we be investing our 401(k)s ($425,000) after retirement? Currently, we are invested 25 percent cash, 30 percent fixed and 45 percent equities. ---J.K. by email from Plano, TX

A. Buffett isn’t alone in his expectations of lower future returns for equities. Rob Arnott makes similar projections of lower returns, concluding that 8 percent is probably on the high side. Ditto John Bogle. The fundamental cause for a reduced future return is that dividend yields are significantly lower than in past periods--- and they have accounted for much of the historical return.

But remember, stocks should always be measured against their fixed-income competitors. Current fixed-income yields are very low. In bonds, most of the return comes from the current yield. As a consequence, an 8 percent equity return is still to be preferred to a 3 percent or 4 percent fixed-income return. You might--- repeat might--- reduce your allocation to equities a bit. You wouldn’t leave them altogether.

The hard part for retirees is this: If your total portfolio return is lower, your withdrawal rate must also be lower.

Q. We have a financial adviser from our bank who is trying to sell us on something called "unit investment trusts"(e.g., Claymore Strategic Income Portfolio plus, series 8) and annuities (something called AXA Equitable) for our IRAs. I am always wary of something that is not a mutual fund for retirement purposes. I am wondering if this is something that a sales commission is paid on, and maybe that is why it is being offered. ---D.A., by email

A. Your intuition is working just fine. Your advisor is a salesperson who is trying to maximize his YTB. That’s Yield-To-Broker, as distinct from Yield-to-YOU. The AXA Equitable product is insurance-based and likely has a hefty commission. More to the point, you already have tax deferral with your IRA; you don’t need to put a tax-deferral vehicle inside your IRA.

Unit investment trusts are more complicated. They generally have a high front-end underwriting cost--- higher, for instance, than the brokerage commission you would pay to buy a similar exchange-traded-fund (ETF). Claymore also offers ETFs. Many unit trusts also present other issues when you go to sell and discover that your broker is the only firm that makes a market, and there is a big spread between what you would pay to buy the security and what you will get if you sell it.

Commissions are NOT evil incarnate. As I’ve noted many times, there are brokers out there who make a good living putting people into good, low-expense-ratio mutual funds. It is also possible to have much higher expenses through a genuine no-load mutual fund than through a front-end load fund. Morningstar, for instance, lists some 12,253 true no-load funds. Of those, 10,755 have expense ratios higher than the 60-basis-point (six-tenths of 1 percent) expense ratio of the major American Funds funds sold by brokers.
The broker at your bank, however, doesn’t appear to have any of those products in his toolbox.

How does the cost of raising a family affect your retirement planning?

The answer is good news, in a backhanded kind of way.

When we have children we voluntarily reduce our adult standard of living so we can raise the kids. Since our adult standard of living is lower than it would otherwise be, we don’t need to replace as much income at retirement.
We could figure this out by using actual estimates--- you can get them by Googling “cost of raising a child” or by checking the links below.

But let’s try a simpler method.

I call it the “N” factor. While there is a great deal of research on how the size and age of a household affects its cost of living, a simple algorithm comes pretty close.

Here’s the algorithm: The cost of living for a household is the square root of the number of people in the household. So if you are single, your cost of living is the square root of 1 or… 1.

But if you are recently married, your cost of living is the square root of 2, or 1.414. Yes, two can’t live for the price of one. But they can live for only 42 percent more than the price of one. Economists call this “economies of shared living.” As economist Laurence J. Kotlikoff and I show in “Spend ‘til the End,” to be released by Simon and Schuster on June 10th, the size of your household while working has a major impact on your retirement needs.

You can understand this by figuring out the cost of raising children.

Using the “N” factor, your cost of living with one child is the square root of 3, or 1.73. Have a second child and your cost of living is the square root of 4, or 2.

So how much of your cost of living is accounted for by having two children?
Answer: About 30 percent. You and your spouse account for the other 70 percent of your cost of living.
Now let’s consider a more concrete example--- a young single-earner couple with an income of $100,000 a year, two children, and the usual assortment of debts. They’ll pay 7.6 percent of their income in employment taxes, about 8 percent in federal income taxes, and they’ll save perhaps 4 percent in a company 401(k) plan

.The conventional wisdom of the financial services industry says they might need to replace as much as 85 percent of income in retirement because the usual 70 to 85 percent rule ignores two of the largest realities of life in America--- debt and children.

Talk about major omissions.

About 25 percent of this couple’s income will go for debt service--- their mortgage, car loans, credit card and education debt. With a bit of attention they can manage to pay off all these debts by the time they retire.

That leaves about 55 percent of their income to pay all their other expenses, including the cost of the kids. But the “N” factor tells us that the kids cost about 30 percent of that--- call it 16 percent of their gross income--- leaving 39 percent for the parents.

Of course, adding taxes back in might increase the percentage of gross income that must be replaced, but the total is still a ballpark away from the 70 to 85 percent used by the financial services industry.

In fact, this household probably won’t pay taxes.

Social Security benefits at full retirement age will replace about 24 percent of a $100,000-a-year worker’s wages. (They will replace a higher percentage for workers who earn less.) The worker’s spouse will be entitled to a spousal benefit equal to half the worker’s benefit, if he or she is the same age. That’s another 12 percent, for a total of 36 percent.

Note that 36 percent is pretty close to 39 percent--- the income they had to spend on themselves most of their adult lives.

Indeed, under current law they could take $18,000 a year (another 18 percent of replacement rate) from their retirement savings plan and still pay zilch in federal income taxes. That means they can spend 54 percent of their pre-retirement income, well over what they had while raising children!

Maybe our collective futures aren’t as dismal as the financial services industry wants us to believe.

On the web:

Q. When I started taking required minimum distributions from my IRAs, I used a withdrawal formula based on dividing the value of my IRA by 27.4. I understood that this value would have to be withdrawn annually until the IRA was depleted. Of course the RMD is taxed at my current tax rate. During a recent discussion with others who are taking RMDs, I was told their withdrawals varied from year to year. I don't understand how that can happen.

Also, I am currently paying taxes on my RMD at the same tax rate I was paying before retirement because I no longer can benefit from itemizing deductions. If, as some of the presidential candidates are planning, tax rates are increased, I will be paying more taxes on my IRA than I would have paid when I invested the money. Have you heard of any efforts to ensure that taxes on RMDs are fixed?---C.B. by email from Carrollton, TX

A. Required minimum distributions from qualified accounts are roughly based on your life expectancy. I say roughly because your life expectancy will vary significantly depending on your sex and race, while the RMD table from the IRS is a single unisex table. The table also allows generous room for the 50 percent who live longer than their life expectancy and for the joint expectancy of couples.

According to a life expectancy table used by the Trustees of the Social Security system, for instance, a 70-year-old has a life expectancy of 13.27 years. The IRS table for required minimum distributions has a distribution period of 27.4 years for the same age. Divide the distribution period figure into 100 and you get the percentage of your account that must be distributed for the first RMD, 3.65 percent.

Your life expectancy doesn’t remain constant. For each additional year, your expectancy decreases. But it doesn’t decrease by a full year. From 70 to 71, for instance, the Social Security table says your expectancy declines to 12.64 years. That’s a loss of 0.63 percent of a year rather than a full year. Your distribution period also declines. From 70 to 71 it falls to 26.5, indicating a distribution of 3.77 percent.

By age 80 the distribution period is down to 18.7 years, a distribution of 5.3 percent. (Your life expectancy at the same time is down to 7.62 years, so it can’t be argued that you’re being unreasonably pushed.)

The longer you live, the greater the RMD as a percentage of your remaining account value. At age 95, when 97 percent of all people born in America can expect to be dead, your RMD is 8.6 years, dictating an 11.6 percent distribution…

One side effect of growing account values and shrinking distribution periods is that many retirees, like you, are finding that their tax rate in retirement is as high as when they were working. Worse, many are paying taxes on their Social Security benefits, making the effective tax rate much higher than when they were working.
I know of no attempts to fix tax rates on RMDs, but there have been several unsuccessful efforts to limit the taxation of Social Security benefits.

Here are some helpful links:

Social Security life expectancy table:
http://www.ssa.gov/OACT/STATS/table4c6.html

Bankrate.com article and RMD table:
http://www.bankrate.com/brm/itax/news/20010321b.asp

Kiplinger’s online RMD calculator:
http://www.kiplinger.com/php/ira/question.htm

Earlier columns on RMDs:
http://assetbuilder.com/search/SearchResults.aspx?q=RMD&g=6

Q. I am considering putting together a Couch Potato portfolio. One thing concerns me, though. It is the size of the bid/ask spread most ETFs seem to have. They seem to range from 2 to 4 percent. I know you are an advocate of low-cost investing, but when you buy at the ask and sell at the bid, plus pay a sales commission, this seems like expensive investing to me. Particularly if you rebalance your portfolio every year, as you should.---R. C., by email from Frisco, TX

A. You should check those bid/ask spreads again. Perhaps some of the small and obscure ETFs have spreads of that size, but I’ve never seen anything like that on actively traded, broad-index ETFs.

Here are two examples using the Fidelity Investments brokerage platform and its reported bid/ask prices. Recently, the bid on Vanguard REIT index ETFs was $65.83 while the ask was $65.85. That 2-cent difference is only 3 basis points--- 3 one-hundredths of 1 percent. Similarly, the spread on iShares TIPS was just 4 cents over the $107.22 bid.

The only thing constant is change---that includes Couch Potato investing. When I created the first Couch Potato portfolio nearly 20 years ago it was a very simple portfolio by both design and necessity.

Design required it be something anyone could do, including those without the vaguest interest in stocks and bonds.

But necessity played a large role too--- at the time there were only a handful of index funds from which to choose. Vanguard, for instance, offered only 4 index funds. So the first Couch Potato portfolio was really simple: one-half Vanguard 500 Index funds for stocks and one-half Vanguard Total Bond Market Index for fixed income. Treasury inflation protected bond funds did not yet exist, nor did emerging market index funds. And there were
only two small cap index funds and one international fund.

Today, we have a multitude of choices for index funds. And we can buy them either as traditional mutual funds or as exchange traded funds. As the index fund market expanded, I began to update and expand the Couch Potato portfolio.

It’s still simple. It’s still very inexpensive. It’s still very tax efficient. And it’s still likely to do better than at least 70 percent of its managed competitors. Using the Building Block technique you can now build a portfolio with as few as two and as many as ten asset class “blocks.”

We report on the trailing period performance of all the Building Block portfolios each month. I believe they will continue to do what they were designed to do--- provide simple portfolios for do-it-yourself investors. More important, their returns are likely to be better than the returns of most managed portfolios. There is a simple reason for this: managers have an exaggerated view of the value they add and charge accordingly.

But a nagging question remains.

Can the Couch Potato portfolios be “tweaked” for better performance and less risk?

That’s what we created AssetBuilder to do.

First, we searched for index funds that provided better returns than Vanguard index funds. That isn’t easy. But we found that Dimensional Fund Advisors, a much respected shop with deep footings in the best academic research, offered just that. Unfortunately, the funds are only available to institutional investors or through registered investment advisors. They cannot be purchased “retail” as Vanguard funds can.

Skeptical? We were too.

So check the links below to download our research and data sources. The shortest (and least academic) comes from Don Phillips at Morningstar. He found, in 2005, that the ten year average total return on DFA funds was 12.37 percent while the comparable figure for all index funds was only 8.94 percent. That’s a handsome difference, a difference that could provide a significant upgrade to any retirement.

The Duke University study, using several approaches, also showed a significant advantage for using DFA funds over Vanguard funds. The advantage was a minimum of 1.19 percent a year.

Second, was to use mean variance optimization to get as close as possible to providing the highest return for any given amount of risk. Trust me, its way more complicated than dividing by a number between 2 and 10 to get your asset allocation. Just talking about MVO is a really good way to empty a room, so it’s clearly not a “home brew” portfolio tool.

That’s what we do at AssetBuilder. We’re absolutely certain that our portfolios aren’t perfect, but MVO is the best tool currently available. We’re confident that time will show that our model portfolios will provide higher net returns with less risk than the vast majority of asset managers.

Why are we so confident? For all the right, Couch Potato-like reasons! Low costs to you and improved risk efficiency. We’re not predicting the future; we’re just offering the most efficient vehicle for market returns.

Supporting Links:

Get started with AssetBuilder today! Take our 4 question survey to help determine your investment style, Compare our Model Portfolio to the major Indices, or call us at 972-535-4040 or email us to learn more!

Lots of explanations are offered for the soaring prices of oil and commodities. You can choose from: (a) the terrorism premium, (b) speculators, (c) peak oil theory, (d) shrinking net exports from oil-producing nations; (e) rising demand from emerging market economies or (f) any combination of the above.

But another reason may be as important: the futility of holding dollar-based investments.

The most recent indication is the May interest rate reset on I Savings Bonds.

These are the Savings Bonds that anyone can buy because they are sold, commission-free, in amounts as small as $50. Indeed, you aren’t allowed to buy more than $5,000 of them in a year.

I Savings Bonds, like Treasury Inflation Protected Securities (TIPS), guarantee the money you invest will be protected from losses of purchasing power due to inflation. This is done by adjusting your principal upward to compensate for inflation, as measured by the Consumer Price Index. In addition to the inflation adjustment, you also receive a fixed premium, giving you a modest “real” return. The premium amount is reset every six months and you receive the premium offered in your purchase period, plus inflation adjustments, for the life of the bond.

When they were first offered nearly 10 years ago, I Savings Bonds paid a premium of 3.40 percent over inflation. Since then the premium has declined as the bonds have become more popular and an increasing number of savers have understood that the total return on these bonds was often higher than the return on conventional savings bonds. Those who bought the early bonds, for instance, are now enjoying returns over 8 percent (3.40 percent premium plus 4.84 percent inflation).

The Diminishing Rewards of I Savings Bonds

But that was then.

Savers were shocked on May 1st when the Treasury announced that I Savings Bonds issued during the next six months would carry a premium of zero. Yes, you read that right.

Zero.

Even so, the annualized “return” on the bonds for the next six months will be 4.84 percent, the annualized inflation rate.

The Treasury Department basically told savers it would condescend to take their money, use it for whatever it chooses, and return it adjusted for inflation.

The inflation adjustment will be deemed “interest,” however, so when the bonds are redeemed savers would, in effect, be taxed for lending money to their government.

For small savers it’s a raw deal. But it is offered in a market filled with raw deals for savers. Conventional savings instruments, whether offered by the Treasury or banks, are no better. All are offering interest rates well below the rate of inflation. And then, adding insult to injury, your interest income will be taxed.

What’s unique about the I Savings Bond rate is that the hosing is so explicit. By having a premium of zero over inflation the Treasury is sending a simple message to savers: Drop Dead.

If American savers are getting a raw deal, how do you think the Chinese government feels about its holdings of depreciating U.S. Treasury obligations? Or the Japanese government? Or the Russian government? Or any holder of Treasury obligations anywhere in the world?

When dollar investments are a sure way to lose purchasing power, commodities become very attractive. That’s when we fill our closets with paper towels, soap, canned goods and any other consumable that can be stored.

Well, that’s what big money is doing all around the world. With no real yield on cash, it says let’s own barrels of oil, ingots of nickel, platinum, and palladium. Let’s own bars of silver and gold coins. Let’s own some grain bins.

For those seeking to protect their wealth, Bubble Risk may be better than worthless paper risk. Small wonder commodities are booming.

On the web:

Q: How can I prove that my company 401(k) plan is a loser? The company I work for has our plan with Putnam. I believe there is no combination of funds in the 401(k) that has ever beaten the S&P 500 index over any period of time.

But I need to figure out how to prove this by collecting the data and displaying it in graphs or other ways to make it clear. Where do I start? Can you point me to somewhere to start on such an analysis -- a software package, a data source, Web site, whatever? -- J.M., by e-mail

A: What you know in your gut is right on. Collecting the data and putting it together is where Morningstar, the Chicago investment data firm, shines. Its fund reports present a standardized format showing trailing returns for a variety of time periods, the percentile ranking of each fund against all the other funds in the same asset class, and a variety of risk measurements. You can get this data by going to www.morningstar.com, clicking on "funds," and entering the ticker for each fund you want to examine. The data can also be obtained by using Morningstar Principia, its mutual fund data service on CD-ROM.

You'll have to do the complete analysis since I don't know which funds are offered in your plan, but here is what makes me think the management at your company may be enjoying two martinis at lunch.

Using Morningstar Principia for the period ending March 31, I found that Putnam has five funds that are categorized as "large domestic blend" funds. These are funds that are benchmarked against the S&P 500 index. According to the Hewitt 401(k) index, this category accounts for nearly 19 percent of all 401(k) plan balances.

Over time periods ranging from the first three months of this year out to 15 years, these funds have averaged returns that trail the benchmark index. They have trailed by very wide amounts (see table below). Beyond that, all but one of the individual funds have ranked miserably against competing funds.

Putnam Tax Smart Equity fund, for instance, has ranked in the 97th, 98th and 92nd percentiles over the last 12 months, three years and five years, respectively.

Putnam Research fund has been in the bottom 10 percent in all recent time periods. But if you go out 10 years, it rises to being beaten by 83 percent of its competition.

Putnam Investors has also been in the bottom 10 percent in all time periods out to 15 years except the five- and 10-year periods, where it managed to be beaten by only 87 percent and 89 percent of competing funds, respectively.

Putnam Capital Appreciation has a similar record. Its best performance was over the last five years, when 86 percent of its competitors provided higher returns.

The only hopeful sign is Putnam Asset Allocation: Growth. This fund was beaten by 71 percent of its large blend competitors in the last 12 months, but it has performed in the top 25 percent over the last five- and 10-year periods.

Putnam's two balanced or moderate allocation funds were also in the bottom half of their category. Putnam fixed-income funds and international funds were somewhat better in performance -- they weren't all bottom of the class -- but there is nothing in the basic numbers to make me think that every employee at your company wouldn't be better off in index funds.

Performance Little Family, One Funds, Five

Bottom line: Your company management could do better. They may, however, suffer a major limitation. If the company is small and the plan involves relatively little in assets, there are plenty of vendor choices, but they are all relatively expensive. That's why I believe IRA contribution limits should be the same as 401(k) and 403(b) plan limits -- employees could easily make a choice of less expensive options for themselves.

ON THE WEB

"Please write an article telling people with less than $15,000 a year of retirement income how they are supposed to survive." — R.S., by e-mail

Millions of people face this predicament. According to the Social Security Administration, Social Security benefits account for 90 percent of income for four of every 10 unmarried retirees and two of every 10 married couples.

Another report on the Social Security Web site tells us that the average Social Security benefit for a retired worker is now $1,082.30 a month. That's before the Medicare part B premium of $96.40.

The solution here isn't more money or another government program.

The solution is social. It is called sharing -- having enough social skill to multiply your effective income to a level far greater than it could be made with ordinary cash.

One of the benefits of the last 50 years is that prosperity has raised our expectations. We expect to own our house, to have our own bedroom, our own bathroom, our own car, our own phone (preferably mobile), our own TV set, and we want to eat what we want for dinner, not what everyone else is having. That makes life very expensive.

The productive social alternative is sharing. Economists call it "economies of shared living." Most of us think about it in regard to marriage. While two people can't live for the price of one, the cost of living doesn't double when you get married. Divorce, on the other hand, involves returning to the dis-economies of non-shared living. That's why one spouse, or both, suffers a lower standard of living after divorce.

Now let's examine how economies of shared living can benefit a retiree. Imagine a single retiree living in a 55-and-over trailer park. She has a monthly net Social Security benefit of $1,000. From that she has to pay $400 for land rent and $300 for the loan payment on the manufactured home. That leaves only $300 a month for food, clothing, transportation and everything else.

It's not a pretty picture.

Now let's imagine the same person as she creates a "family" of retirees. She has a 1,400-square-foot doublewide with four bedrooms and two bathrooms. Let's see how things change as she builds her "family" and they pool their income to share their expenses.

• With one roommate with the same net income, the household income doubles to $2,000. That leaves $1,300 after shelter expenses. That's tight, but two people can eat and buy other necessities with $1,300 a month. In effect, each person has $650 a month to live on after shelter expenses, simply by living together.
  
  
• Add a second roommate and income triples to $3,000. That leaves $2,300 after shelter expenses. Each person now has $767 a month for living expenses beyond shelter.
  
  
• Have a third roommate and income quadruples to $4,000. This leaves $3,300 after shelter expenses. With this much shared income, each person has now has $825 a month.

There are limits to this, of course, but the cost of shelter is the beginning of communal sharing, not the end. The same group of four could share meals, share a car and anything else they can agree on. Suppose, for instance, the group decides to share a car that costs an average of $300 a month. And suppose food costs $400 a month for the first person and $200 a month for each additional person. What happens?

Do that and the single person living alone goes from a deficit of $400 a month to a surplus of $200 a month -- just by sharing with one person. Build the community to four people and each will have a monthly cash surplus of $450 a month.

That's $450 a month after food, shelter and transportation. These four retirees would have group income of $48,000 a year, on which they pay no taxes. While their individual income was at the poverty level, their collective income is about the median pre-tax income of all American households -- $48,201 in 2006.

Note that this is not a utopian commune or a spiritual community. It's just four retirees figuring out how to get along in a trailer park. Some readers -- perhaps R.S. -- will say that making such arrangements isn't that easy.

They'd be right. But sharing offers a major "return" for being creative and flexible. Cooperation is a wonderful but generally overlooked substitute for money.

ON THE WEB

Q. I wonder if single-premium immediate annuities (SPIAs) are for me. I am 75. My wife is 73. We have no debt, $850,000 in IRAs (mostly in the American Fund family) and $150,000 in a ROTH, again with American. We also have $150,000 in CDs and money markets in taxable accounts.

We live decently on Social Security, pensions and my IRA minimum required distributions. I don't feel that I can think very "long term." So I want to avoid some market risk. SPIAs have come to my attention via an AARP offer with NY Life. I am considering spreading some of my funds around in laddered SPIAs. Is this a good idea? Most financial advisers I have spoken with jump immediately to variable annuities (with "living benefits"), I suspect due to larger commissions. ---D.P., by email

A. You’re on the right track and, yes, the sales people who promote the living-benefit route ARE receiving handsome commissions. You can reduce your risk and possibly increase your estate by doing exactly what you suggest--- laddering a number of single-premium life annuities. While the principal will be gone, your current monthly payments will increase. Less (or none) of your required minimum distributions will need to come from liquidating equity investments. You’ll get the security of a solid monthly income, and your equity investments may grow with less risk of being sold in a down market.

Research has shown that using some amount of SPIAs is a good option for all households, including those with a desire to leave some money to heirs. As I pointed out in an earlier column, the expenses of a popular living-benefit product are so high that you’d be far better off dividing your existing money between a life annuity and regular low-cost mutual funds.

Q. I am 70 and own a house in need of repairs such as foundation work, floor leveling, window replacement (windows are aluminum frame and drafty), and repainting. With repairs, my debt-free house would be worth about $95,000. I also have $200,000 in financial assets. Since I live on Social Security income and a little interest from my savings accounts, I think I would be better off getting a reverse mortgage rather than taking out a home improvement loan. What do you think? I am in good health and will probably live another 20 years. My only debt is $1,500 in credit card bills for auto repair. ---N.C., by email from Greenville, TX

A. Reverse mortgages have come a long way in the last ten years, but they are still an expensive way to finance much of anything. The interest rates are higher than the rates on conventional home mortgages, and the cost associated with putting a loan in place also raises the effective cost of accessing your equity. This is particularly true with relatively small loans, as yours would be. So if you have to borrow money for repairs, you might consider a home equity line of credit. These loans have relatively low (but variable) interest rates. Most can be done with no front-end cost to you. Recently, interest rates on these loans were about 5.25 percent. Borrowers often get a small break for arranging to have the monthly interest payment automatically deducted from their checking account, if they bank where they borrow.

The caveat on home equity lines of credit is that the interest rate is variable, so it could rise to an uncomfortable level. This, however, should not be a problem for you since you have $200,000 in financial assets. If future interest charges rise to an uncomfortable level, you’ve got the money to simply pay the loan off.

Another thing you should consider is selling your house and becoming a renter. The future will hold more repairs. Your desire to do home maintenance yourself isn’t going to increase over time. If you sold your house, you could add to your savings and eliminate all the chores of ownership. While rental markets vary all around the country, in the Dallas area it is possible to find apartments where the monthly rent and utilities will be similar to the operating and repair costs of your current house.

On the web: