Money Management Q&As

January 6, 2006

Automatic enrollment in a 401(k) plan

Q To increase employee participation in our practice's 401(k) plan, we'd like to enroll new employees in it unless they indicate otherwise. Is there a ceiling on the percentage of salary that can be automatically deferred?

A No. Although it's commonly 3 percent, the IRS says the plan can set any percentage initially, increase it later, and apply it to raises or bonuses received on top of base salary. Be mindful that you must give new employees time to opt out before deferrals begin, notify them in advance of plan revisions, and allow them to change their minds in the future.

Q I'd like to build a portfolio of bonds with staggered maturities. I've heard some people talk about a "ladder" strategy and others a "barbell" strategy. Is there a difference?

A Yes. Laddering involves buying a sheaf of bonds whose maturities are more or less evenly spaced-for instance, 10 bonds maturing two years apart over 20 years. As each bond matures, you replace it with another to maintain the ladder. With a barbell approach, you initially put half your money into bonds with short-term maturities, say five years, and half into long-term issues, say 15 or 20 years. Either method gives the portfolio a relatively stable income stream, because interest-rate fluctuations have less effect on the value of short bonds than on that of long bonds. In exchange for stability, you sacrifice some return, since long-term issues pay a higher rate than short ones of comparable quality.

Getting insurance if you don't own a car

Q Owning a car is a nuisance for a city dweller like me, so I rent one when I need to and buy insurance from the rental company. A friend told me it would be cheaper to get my own policy. Is he right?

A Most likely, yes-a nonowner's policy runs about $300 a year. But such a policy will leave you bare if you get into an accident and sustain serious damage to the vehicle. That's because it doesn't provide collision coverage, which you'll have to buy from the rental company. About the only time a nonowner's policy would make sense is in cases where your credit card company provides an adequate amount of liability coverage. So check with your card company first.

Funding college costs years ahead of time

Q I want to build an education kitty for my son, who'll be starting college in about 15 years. I can't decide whether to invest in a conservative mutual fund or a more-aggressive fund that offers a higher return. Is there a sensible compromise?

A Yes. You can get the best of both worlds by going for growth in the earlier years, then shifting to a more-balanced portfolio as the need to meet your son's college costs draws closer. A number of mutual funds designed to do this for future retirees may be equally suitable for your purpose-T. Rowe Price's Retirement series and Vanguard's Target Retirement funds, for example. Better yet, look for a state-sponsored 529 plan with similar features and tax advantages as well.

How P/E ratios affect investment strategy

Q My broker favors stocks with high price-earnings ratios, which he says indicate excellent growth potential. But I worry that I'll lose money on them if they don't live up to expectations. In the long run, can you count on high-P/E issues to outperform low-P/E stocks?