This resolution is for your mid sixties self. If you haven't met him or her there are aps out there whereby you can take a picture of yourself and age it. If you have problems saving then do it and meet your future self. It helps some people.
Now I know many people don't like to think about getting older. Get over it. I'm older and semi retired and it's great. Admittedly there are days where it is harder to get up in the morning and I get tired earlier in the evening. But balanced against this is the wisdom I've gained over the years ;) I don't do nearly as many stupid things as in my youth.
Anyways what about the resolution? It is simple. Save at least 15% of your paycheck towards your retirement. Not for a new pick up truck, not for an exotic vacation but towards your retirement. Have it taken out of your paycheck and learn to live on what is left.
Ok, so now you're protesting. You can't live the life style you are accustomed to if you are putting aside 15%. First off consider that for some (many?) of you it isn't 15% less income because you get a tax break if using a 401(k) or an IRA and secondly some of you have a company match. So, to get at the 15% isn't such a burden.
But if it is still a stretch take a hard look at your lifestyle. Think about functionality versus other motives for what you spend on. Is that car for getting from point A to point B or is it to send a message that you hope gets people to think you are making the big bucks.
Thorsten Veblen
wrote a famous book, The Theory of the Leisure Class, in 1899 in which he introduced the concept of "conspicuous consumption". The idea was that people emulate the economic class above them. As such we buy many things not for their use but for the image they project. Consider that we buy silverware because it is similar to what the wealthy use not for its functionality.
Granted that Veblen may not be the easiest to relate to in today's world. Instead you may want to check out
Money Mustache.
IMHO he is the best current writer on frugality and the early retirement movement. If he can't inspire you to live a more moderate life style then you are uninspirable.
Bottom line: Resolve to save at least 15% of income in 2017. Your future self will thank you!
Friday, December 23, 2016
Wednesday, December 21, 2016
I Apologize
I apologize to all those people over the past three years to whom I talked and tried to the best of my ability to get into the stock market. I wish I was more persuasive. We sat together at the table (or Skyped) and looked at the huge amount you had in Certificates of Deposit at .75% or in money markets at 0.1% and I pleaded for you to open an account at Schwab (or the discount broker of your choice) and choose a low fee S&P 500 Index Fund for 60% of the assets.
I argued that the U.S. economy is the most innovative in the world, that products will be forthcoming that neither of us could foresee that would be in demand. We couldn't foresee Fitbits, or driverless trucks, or drones delivering packages. We couldn't foresee virtual reality. But all of it came and is coming big time.
You worried over government shutdowns, a slowing economy, the European Union breaking up and more recently Brexit and Trump. In your thinking you kept going back to the downturn in 2008 despite the fact that you had many years to recover if the market experienced a meltdown in the short run. To no avail I tried to emphasize that such a meltdown is a gift to the long term investor who is accumulating a nest egg for retirement.
The saving grace for me are the many who did invest for the first time and who gained the confidence and knowledge that put them on the path they need to be on. They held to a well defined asset allocation and have seen their assets appreciate significantly to return well above the rate of inflation. They learned to manage their own assets and avoid the egregious fees charged by the industry.
They are excellent examples of how straight forward it is to become do-it-yourself investors and participate fully in the free market capitalistic system.
I argued that the U.S. economy is the most innovative in the world, that products will be forthcoming that neither of us could foresee that would be in demand. We couldn't foresee Fitbits, or driverless trucks, or drones delivering packages. We couldn't foresee virtual reality. But all of it came and is coming big time.
You worried over government shutdowns, a slowing economy, the European Union breaking up and more recently Brexit and Trump. In your thinking you kept going back to the downturn in 2008 despite the fact that you had many years to recover if the market experienced a meltdown in the short run. To no avail I tried to emphasize that such a meltdown is a gift to the long term investor who is accumulating a nest egg for retirement.
The saving grace for me are the many who did invest for the first time and who gained the confidence and knowledge that put them on the path they need to be on. They held to a well defined asset allocation and have seen their assets appreciate significantly to return well above the rate of inflation. They learned to manage their own assets and avoid the egregious fees charged by the industry.
They are excellent examples of how straight forward it is to become do-it-yourself investors and participate fully in the free market capitalistic system.
Saturday, December 17, 2016
Are You Freaking Out About Bonds?
Interest rates are rising and do-it-yourself investors know that pushes bond prices down. The mainstream media loves this kind of story. Scaring investors is a whole genre within the financial reporting sphere. The reporting today anticipates the shock coming when investors check out their quarterly statements.
Well, actually (here's the news for the mainstream news) most investors, if interested, can go online and see their up-to-date results. Waiting for quarterly statements is last century for many investors, especially DIY investors.
So, what about bonds? Let's take the perspective of an investor, i.e. someone who invests longer term.
The index most widely used to measure bond market performance is the
Barclay's (formerly Lehman) Aggregate Bond Index.
It is an intermediate bond index and is to the bond market what the S&P 500 is to the stock market. It tracks all investment grade bonds in the U.S. with a maturity of greater than one year (once a bond comes to within a year of maturity it is dropped from the index). Thus, the index includes U.S. Treasury Notes and Bonds, Corporate issues, and U.S. Agency issues. It is the most widely used benchmark by professional bond managers to assess and report on their performance. As a point of reference, most surveys are reporting that professional, active bond managers are under performing the Aggregate Index this year.
So how has it done? The yield on the benchmark 10 year Treasury Note has had a nasty back up from 2.22% at the beginning of the year to 2.60% as of Friday's close. So what has been the impact on performance? Shorter term the fear mongers are right. Over the past 3 months the Index has had a total return of -3.55%. But for the year-to-date the return is +1.62%! Pretty good compared to what people are getting on certificates of deposit and especially on money market fund.
In fairness, the return is not great compared to inflation. Still not something to freak out about. The yield on the index is 2.36% and this will be an important return determinant of the the longer term performance.
Most often investors capture this return by using the
AGG
exchange traded fund which has an expense ratio of .06%, i.e. 6 basis points.
Also, it is notable that, just as there are many way to play off the S&P 500 in the stock market, there are many ways to buy bond index funds that will perform differently than the Barclay's Aggregate Index. There are funds, for example that focus on different sectors and funds that have much different durations.
The above information as well as much more can be found by plugging the ticker symbol AGG into
Morningstar.
You'll note at the site that there is a "performance" link which provides up-to-date performance.
Well, actually (here's the news for the mainstream news) most investors, if interested, can go online and see their up-to-date results. Waiting for quarterly statements is last century for many investors, especially DIY investors.
So, what about bonds? Let's take the perspective of an investor, i.e. someone who invests longer term.
The index most widely used to measure bond market performance is the
Barclay's (formerly Lehman) Aggregate Bond Index.
It is an intermediate bond index and is to the bond market what the S&P 500 is to the stock market. It tracks all investment grade bonds in the U.S. with a maturity of greater than one year (once a bond comes to within a year of maturity it is dropped from the index). Thus, the index includes U.S. Treasury Notes and Bonds, Corporate issues, and U.S. Agency issues. It is the most widely used benchmark by professional bond managers to assess and report on their performance. As a point of reference, most surveys are reporting that professional, active bond managers are under performing the Aggregate Index this year.
So how has it done? The yield on the benchmark 10 year Treasury Note has had a nasty back up from 2.22% at the beginning of the year to 2.60% as of Friday's close. So what has been the impact on performance? Shorter term the fear mongers are right. Over the past 3 months the Index has had a total return of -3.55%. But for the year-to-date the return is +1.62%! Pretty good compared to what people are getting on certificates of deposit and especially on money market fund.
In fairness, the return is not great compared to inflation. Still not something to freak out about. The yield on the index is 2.36% and this will be an important return determinant of the the longer term performance.
Most often investors capture this return by using the
AGG
exchange traded fund which has an expense ratio of .06%, i.e. 6 basis points.
Also, it is notable that, just as there are many way to play off the S&P 500 in the stock market, there are many ways to buy bond index funds that will perform differently than the Barclay's Aggregate Index. There are funds, for example that focus on different sectors and funds that have much different durations.
The above information as well as much more can be found by plugging the ticker symbol AGG into
Morningstar.
You'll note at the site that there is a "performance" link which provides up-to-date performance.
Tuesday, December 6, 2016
A Great Gift
Recently I received a call from a young man seeking my advisory services. As an advisor my satisfaction comes from helping people get on a path to a successful retirement. This means steering them clear of high priced advisors who underperform, avoiding costly Funds that overcharge, and ensuring that the size of their nest egg will be sufficient to produce the income they need in retirement.
But this young man was a different case than I usually handle. He had just gotten out of prison on drug related charges and while in prison had read "Millionaire Teacher", which he found in the prison library, by Andrew Hallam. By reading the book he had come to understand how people build wealth by saving and investing intelligently. The book inspired him to do the same and he enlisted my services to get going. Full disclosure: I, along with a couple of other advisors, are mentioned in the book.
He related to me how his parents and entire family are poor but he had attained a job and was primed to start investing on a regular basis. To say the least this was one of my most satisfying consultations.
But the bottom line here is receiving the methodology. Admittedly, there are a number of books that describe how to invest in low cost Funds, allocate assets, and rebalance as needed. "Millionaire Teacher" is one and it is a good one. It is well written and can be read in a couple of weekends.
In my opinion it is a great life changing gift, especially for the young couple ( many of whom are financially illiterate) starting out in the professional work world. But many in mid-career find it useful as well.
So, I suggest instead of showing up with the soon to be consumed bottle of wine at the holiday party or putting a DVD of "Deadpool" under the tree consider "Millionaire Teacher". It is an excellent choice for the budding DIY investor. As this blog and many others have harped on for a long time DIY investing done intelligently can save huge amounts and increase the size of the nest egg over longer periods of time.
For additional background check out Andrew Hallam's website.
But this young man was a different case than I usually handle. He had just gotten out of prison on drug related charges and while in prison had read "Millionaire Teacher", which he found in the prison library, by Andrew Hallam. By reading the book he had come to understand how people build wealth by saving and investing intelligently. The book inspired him to do the same and he enlisted my services to get going. Full disclosure: I, along with a couple of other advisors, are mentioned in the book.
He related to me how his parents and entire family are poor but he had attained a job and was primed to start investing on a regular basis. To say the least this was one of my most satisfying consultations.
But the bottom line here is receiving the methodology. Admittedly, there are a number of books that describe how to invest in low cost Funds, allocate assets, and rebalance as needed. "Millionaire Teacher" is one and it is a good one. It is well written and can be read in a couple of weekends.
In my opinion it is a great life changing gift, especially for the young couple ( many of whom are financially illiterate) starting out in the professional work world. But many in mid-career find it useful as well.
So, I suggest instead of showing up with the soon to be consumed bottle of wine at the holiday party or putting a DVD of "Deadpool" under the tree consider "Millionaire Teacher". It is an excellent choice for the budding DIY investor. As this blog and many others have harped on for a long time DIY investing done intelligently can save huge amounts and increase the size of the nest egg over longer periods of time.
For additional background check out Andrew Hallam's website.
Wednesday, November 16, 2016
Can You Retire Early?
Here's a neat little chart from businessinsider "How close am I to early retirement"? Just find your income level and then the difference between your spending and saving. The answer as shown in the chart is how long it takes to build a next egg you can retire on by taking the magical 4%/year. Do this and you won't run out of money.
Simple? Yes, but useful as a general guide.
The problem is tricky as I've written several times on this blog. You've got inflation, market performance, how long you will live, medical costs and all sorts of unknowns. Some people take more comfort in getting complex analyses which produce Monte Carlo scenarios etc. To me simple is better. But it is very important to revisit the issue every couple of years at a minimum to see where you stand.
Some people target a number. For example they might have $1 million as the value of their nest egg at which they can retire. A problem here is that the number will be hit when the market is at a high point. I had a distraught individual who came to me after he had retired in 2000 and then went through the dot.com bust and had to go back to work. He then retired after the market hit a record high in 2007 and then experienced the 2008 down 37% market. Needless to say he was at wit's end!
One way to approach this is to consider 4% of 80% of your portfolio. Can you have a nice retirement off of this? It may not be ideal but would it be ok? For example, if your nest egg is $1 million then 4% of 80% (.04 * $800,000) would be $32,000. If this would be ok (combined, of course, with Social Security etc.) then you could withstand a downturn in the market.
But back at the chart, what I really like is the out front emphasis on income and sending. The gap is what is key and it is important to not get lost in the weeds with all the other moving parts!
Simple? Yes, but useful as a general guide.
The problem is tricky as I've written several times on this blog. You've got inflation, market performance, how long you will live, medical costs and all sorts of unknowns. Some people take more comfort in getting complex analyses which produce Monte Carlo scenarios etc. To me simple is better. But it is very important to revisit the issue every couple of years at a minimum to see where you stand.
Some people target a number. For example they might have $1 million as the value of their nest egg at which they can retire. A problem here is that the number will be hit when the market is at a high point. I had a distraught individual who came to me after he had retired in 2000 and then went through the dot.com bust and had to go back to work. He then retired after the market hit a record high in 2007 and then experienced the 2008 down 37% market. Needless to say he was at wit's end!
One way to approach this is to consider 4% of 80% of your portfolio. Can you have a nice retirement off of this? It may not be ideal but would it be ok? For example, if your nest egg is $1 million then 4% of 80% (.04 * $800,000) would be $32,000. If this would be ok (combined, of course, with Social Security etc.) then you could withstand a downturn in the market.
But back at the chart, what I really like is the out front emphasis on income and sending. The gap is what is key and it is important to not get lost in the weeds with all the other moving parts!
Saturday, November 12, 2016
What's Next?
Ok, so you've listened to Bogle and Buffett, you've read Bernstein and Malkiel. Now you want to get started investing in low cost index Funds. You've got numerous accounts: 401(k)s, IRAs, taxable accounts etc. You've got capital gains to think about and a host of questions on how to get going.
My suggestion is to find a Registered Investment Advisor (RIA) you can work with. This is code for "who is an adherent of the low cost index Fund approach". If you (1) have made trades and know what ticker symbols are etc., (2) can withstand volatility in your portfolio and (3) are willing to spend some time continuing to be educated on the investment process as it relates to creating a retirement
"nest egg", then you are likely a good candidate for hourly consultation or having the RIA invest for a short-term period to set the account up and then doing your own investing. From the start you save advisory fees of 1% to 2% as well as avoid high cost Funds that tend to underperform the market.
In my practice I do a session for $160. During the session we typically Skype and look at the investments, talk about goals, talk about how big the nest egg should be saved at various ages, how much should be saved, risk tolerance and Funds to be invested in. Sometimes we go over the process of rolling over 401(k)s, withdrawal strategies etc.
Many times this is enough to get the do-it-yourself investor headed in the right direction. Other times I manage assets for a short term period at a low rate of 0.4% per year. If for instance the account is $600,000, I charge $600 for the first 3 months. If at that point the client is ready to take over then that's it - no further charge. Typically, the client will schedule a session for $160 approximately 12 months later.
Some clients of course have me manage their assets on an ongoing basis. They have other things in their daily work life or even in retirement they would rather do than to be managing their assets.
Why an RIA? Good question. Because RIAs are fiduciaries and as such are required to tell you if they have conflicts of interest in regards to compensation. That is, do they get commissions from referring you to people or selling products? Many are like me and the only compensation they receive is what their clients pay them. This is the primary factor in determining that RIAs do what is in the clients' best interests!
My suggestion is to find a Registered Investment Advisor (RIA) you can work with. This is code for "who is an adherent of the low cost index Fund approach". If you (1) have made trades and know what ticker symbols are etc., (2) can withstand volatility in your portfolio and (3) are willing to spend some time continuing to be educated on the investment process as it relates to creating a retirement
"nest egg", then you are likely a good candidate for hourly consultation or having the RIA invest for a short-term period to set the account up and then doing your own investing. From the start you save advisory fees of 1% to 2% as well as avoid high cost Funds that tend to underperform the market.
In my practice I do a session for $160. During the session we typically Skype and look at the investments, talk about goals, talk about how big the nest egg should be saved at various ages, how much should be saved, risk tolerance and Funds to be invested in. Sometimes we go over the process of rolling over 401(k)s, withdrawal strategies etc.
Many times this is enough to get the do-it-yourself investor headed in the right direction. Other times I manage assets for a short term period at a low rate of 0.4% per year. If for instance the account is $600,000, I charge $600 for the first 3 months. If at that point the client is ready to take over then that's it - no further charge. Typically, the client will schedule a session for $160 approximately 12 months later.
Some clients of course have me manage their assets on an ongoing basis. They have other things in their daily work life or even in retirement they would rather do than to be managing their assets.
Why an RIA? Good question. Because RIAs are fiduciaries and as such are required to tell you if they have conflicts of interest in regards to compensation. That is, do they get commissions from referring you to people or selling products? Many are like me and the only compensation they receive is what their clients pay them. This is the primary factor in determining that RIAs do what is in the clients' best interests!
Thursday, November 10, 2016
Market Reaction to Trump
This from Yahoo Finance, "How Wall Street is trying to make sense of the stunning stock market rally"
Stock prices crashed as it became clear that Donald Trump would be elected the next President of the United States. And then they did a complete reversal to actually rally during the first trading day after the votes were counted.Just when you thought the stock market was starting to make sense, it goes ahead and does the exact opposite.The markets were supposed to get crushedAhead of Election Day, Wall Street’s stock market experts were in broad agreement that a surprise victory by Republican candidate Donald Trump would be met by a sharp sell-off, ranging somewhere between -3% to -15%. Yahoo Finance reported on this multiple times.
This is another example of the futility of trying to time the market. There also is some "recency bias" apparently going on. This is where investors give weight to what has happened in similar situations in the recent past. On this front not long ago investors saw the head fake from the Brexit situation whereby stocks dropped and then reversed sharply.
Market time at your own risk.
Sunday, November 6, 2016
Can you find a growth fund that will return 12% over the long term?
Debt elimination guru Dave Ramsey argues that people should eliminate all debt and then invest in a growth fund that returns 12%/year. By the rule of 72 money doubles every 72/12 = 6 years. Sweet!
I, with just about everyone who is familiar with Ramsey, admires his work on the debt side. He has helped thousands get out of and stay out of debt.
But his investment advice is misleading and potentially harmful. Finding a Fund that averages 12% over the long term is like trying to find the next triple crown winner. Good luck! And as he further recommends taking 8%/year out of your nest egg can lead to the outcome that is most feared by retirees - running out of money.
Actually, people don't tend to run out of money - they tend to run out of lifestyle. Draw down at too great a rate and one morning you wake up and realize you can't visit the kids as often, you can't eat out as often, and (drat it!) you have to ask your boss at Wal Mart if you can get more hours!
But the good thing about living in the internet age is that it is fairly easy in most instances to research claims or for that matter just about anything you are interested in. People do this in many areas but not so much in finance.
For example, Google "Large Company Stock Returns" and you'll come up with a link that shows the following table:
This table is reported by Kiplinger and the data comes from Morningstar. These Funds are the top performers out of tens of thousands of Funds.
Looking under the 10 year and 20 year columns you see no 12% s. As you do your research you'll find that Ramsey uses the non sensical arithmetic average whereas the appropriate average is a compound annual number.
But the idea here extends beyond Dave Ramsey and his investment advice. Suppose you want to know what Warren Buffet suggests as an investment approach for the average investor. Or, you have an annuity and, like most people including those who sell them, you can't make heads nor tails of it. Just go on a good search engine and look them up.
Doing the research ahead of meeting with professionals is especially useful because once the jargon starts flying the will weakens and when it comes to financial products people just give in. To hammer this home think of going in to meet with an attorney to discuss setting up a donor advised fund. If you are like most people you may be a bit intimidated in meeting with an attorney. Do a little research and this stress will be reduced and you'll be able to follow the pros and cons as presented and in the end be able to make a better decision. It is all a benefit of living in the information age.
I, with just about everyone who is familiar with Ramsey, admires his work on the debt side. He has helped thousands get out of and stay out of debt.
But his investment advice is misleading and potentially harmful. Finding a Fund that averages 12% over the long term is like trying to find the next triple crown winner. Good luck! And as he further recommends taking 8%/year out of your nest egg can lead to the outcome that is most feared by retirees - running out of money.
Actually, people don't tend to run out of money - they tend to run out of lifestyle. Draw down at too great a rate and one morning you wake up and realize you can't visit the kids as often, you can't eat out as often, and (drat it!) you have to ask your boss at Wal Mart if you can get more hours!
But the good thing about living in the internet age is that it is fairly easy in most instances to research claims or for that matter just about anything you are interested in. People do this in many areas but not so much in finance.
For example, Google "Large Company Stock Returns" and you'll come up with a link that shows the following table:
This table is reported by Kiplinger and the data comes from Morningstar. These Funds are the top performers out of tens of thousands of Funds.
Looking under the 10 year and 20 year columns you see no 12% s. As you do your research you'll find that Ramsey uses the non sensical arithmetic average whereas the appropriate average is a compound annual number.
But the idea here extends beyond Dave Ramsey and his investment advice. Suppose you want to know what Warren Buffet suggests as an investment approach for the average investor. Or, you have an annuity and, like most people including those who sell them, you can't make heads nor tails of it. Just go on a good search engine and look them up.
Doing the research ahead of meeting with professionals is especially useful because once the jargon starts flying the will weakens and when it comes to financial products people just give in. To hammer this home think of going in to meet with an attorney to discuss setting up a donor advised fund. If you are like most people you may be a bit intimidated in meeting with an attorney. Do a little research and this stress will be reduced and you'll be able to follow the pros and cons as presented and in the end be able to make a better decision. It is all a benefit of living in the information age.
Thursday, October 27, 2016
Grant Cardone Shuns 401 (k)
Grant Cardone gave an interview on CNBC trashing the 401 (k) as a savings vehicle, "Self-made millionaire: Don't put money in your 401(k)".
If you're like me you're wondering "who is Grant Cardone"? Google his name and you find that he is a motivational speaker, specializing apparently in teaching people how to sell. In other words, he is a self promoter. If the thought is crossing your mind that we have too much self promoting already we are on the same page.
Mr. Cardone claims he made his first million at the age of 30. He was 30 years old in 1988. For the record, if he had $1 million in a 401(k) back then, invested in the S&P 500, today it would be worth approximately $8 million ( (1.07864 ^ 28) * $1.0 million).
I'm sure he is worth considerably more and could probably easily find out by buying the book he is promoting. I'm sure in his mind he can take people off the street and turn them into millionaires using his sales techniques.
All of this of course is quibbling about hypotheticals in my view. What I do have a problem with is the message to stay away from the 401(k) and try to become a millionaire. The planet is littered with people who have tried and failed and have no back up.
Look at like this. Kids spend the summer lifting weights, throwing a football through a tire and running wind sprints. Then the fall comes and the tryouts for quarterback are upon them and only one gets to be the starting quarterback. Similarly, kids take dance lessons, singing lessons etc. and then the tryout for the lead in the school play is held. One person gets it.
There is only one Tom Brady. Telling people to forget the 401(k) and seek a fortune by starting a business is like counseling a high school quarterback to try and become a low draft pick and be the next Tom Brady. I suggest having a back-up plan just in case.
Mr. Cardone states, "Why would I go to work, have my employer give me another $6,000 a year, and then take that money and send it off to Wall Street, where I can't even touch it for 30 years?
The answer is pretty straight forward: because by doing so you are investing in the greatest wealth creating economy the world has ever known in the beginnings of the information age betting on entrepreneurs creating products we cannot even begin to imagine. To most people this makes sense when they realize that the day is coming when they will be 65 years old.
If you're like me you're wondering "who is Grant Cardone"? Google his name and you find that he is a motivational speaker, specializing apparently in teaching people how to sell. In other words, he is a self promoter. If the thought is crossing your mind that we have too much self promoting already we are on the same page.
Mr. Cardone claims he made his first million at the age of 30. He was 30 years old in 1988. For the record, if he had $1 million in a 401(k) back then, invested in the S&P 500, today it would be worth approximately $8 million ( (1.07864 ^ 28) * $1.0 million).
I'm sure he is worth considerably more and could probably easily find out by buying the book he is promoting. I'm sure in his mind he can take people off the street and turn them into millionaires using his sales techniques.
All of this of course is quibbling about hypotheticals in my view. What I do have a problem with is the message to stay away from the 401(k) and try to become a millionaire. The planet is littered with people who have tried and failed and have no back up.
Look at like this. Kids spend the summer lifting weights, throwing a football through a tire and running wind sprints. Then the fall comes and the tryouts for quarterback are upon them and only one gets to be the starting quarterback. Similarly, kids take dance lessons, singing lessons etc. and then the tryout for the lead in the school play is held. One person gets it.
There is only one Tom Brady. Telling people to forget the 401(k) and seek a fortune by starting a business is like counseling a high school quarterback to try and become a low draft pick and be the next Tom Brady. I suggest having a back-up plan just in case.
Mr. Cardone states, "Why would I go to work, have my employer give me another $6,000 a year, and then take that money and send it off to Wall Street, where I can't even touch it for 30 years?
The answer is pretty straight forward: because by doing so you are investing in the greatest wealth creating economy the world has ever known in the beginnings of the information age betting on entrepreneurs creating products we cannot even begin to imagine. To most people this makes sense when they realize that the day is coming when they will be 65 years old.
Monday, October 24, 2016
Can't Save? Think Again.
Probably the number one excuse for not saving for retirement is that people need every single penny of their paycheck. Most of us have been there and done that. This isn't just at the lower end of the economic spectrum but admittedly is most prevalent there. At least that's the most frequent response I get from people. The "I can barely make ends meet as it is, how am I supposed to make contributions to a 401(k) or an IRA " is a frequent refrain.
But the fact of the matter is people are already saving. It is forced saving. Out of every paycheck 7.65% is deducted for Social Security and Medicare. Think about this. If this was a choice I would be willing to make a sizable bet that many people would opt out and take the 7.65% each paycheck. Clearly this would exacerbate the retirement crisis that is building in this country. Sadly, many people have to be coerced into doing what is good for them.
To hammer home the idea imagine the task of trying to find people, especially as you move down the economic spectrum who don't welcome with open arms their monthly Social Security payment.
As you think about this you realize that this retirement payment is made through the years as you pay off your student debt, take on a house mortgage, have medical problems, have car payments, consider college for the kids etc. In other words, through all the usual excuses for putting thinking about retirement on the back burner.
An important corollary to all of this is that saving is more important than market returns in building a retirement nest egg, especially in the beginning. But many people use the uncertainty of the capital markets as an excuse to shy away. Know this: saving dominates. In fact, as is widely stated savers who are building a nest egg should cheer a negative stock market which gives them an opportunity to buy in at more attractive prices.
But the fact of the matter is people are already saving. It is forced saving. Out of every paycheck 7.65% is deducted for Social Security and Medicare. Think about this. If this was a choice I would be willing to make a sizable bet that many people would opt out and take the 7.65% each paycheck. Clearly this would exacerbate the retirement crisis that is building in this country. Sadly, many people have to be coerced into doing what is good for them.
To hammer home the idea imagine the task of trying to find people, especially as you move down the economic spectrum who don't welcome with open arms their monthly Social Security payment.
As you think about this you realize that this retirement payment is made through the years as you pay off your student debt, take on a house mortgage, have medical problems, have car payments, consider college for the kids etc. In other words, through all the usual excuses for putting thinking about retirement on the back burner.
An important corollary to all of this is that saving is more important than market returns in building a retirement nest egg, especially in the beginning. But many people use the uncertainty of the capital markets as an excuse to shy away. Know this: saving dominates. In fact, as is widely stated savers who are building a nest egg should cheer a negative stock market which gives them an opportunity to buy in at more attractive prices.
Sunday, October 16, 2016
Is This an Accumulator or a Decumulator Market?
In the simplistic world of financial planning you fall into one of three categories: an accumulator building a nest egg, a decumulator drawing down your nest egg and a live for today, borrow and spend type who will worry about retirement when it gets here. For the record there are too many in this latter category.
All three show up on the investment manager/financial planner's doorstep and the fact is only the first two can be helped unless the live for today person has had a revelation and has years to go before they want to build a nest egg or happily has been the beneficiary of an inheritance, won the lottery etc.
So what about the market for the accumulator and decumulator categories? Here are some market indices as reported by Schwab in their performance module. The returns are thru the close of business on 10/14/2016:
Market Index 3 months YTD 1 year 5 years
S&P 500 -0.9 6.17 9.30 14.15
MSCI EAFE 1.22 -.47 -1.05 5.56
Russell 2000 1.21 8.01 8.25 12.77
Barclay's Bond -0.50 5.08 3.84 3.10
Citi 3-mo. TB 0.07 0.20 0.21 0.08
S&P GSCI 1.60 7.72 -11.53 -13.54
Note that the 5 year number is an average annualized return. The S&P GSCI is an index of commodities produced by Goldman Sachs. The Citi 3-mo. TB (Treasury bill) return is a proxy for cash equivalent investments.
From one perspective the returns have been good for both the accumulator and the decumulator. They have been good for the accumulator because positive returns keep people in the market. On the other hand positive returns means the market is getting more pricey and sometimes gets investors to take more risk than they should. Accumulators would actually be better off if the returns were negative because then they could pick up shares at a lower price and the probability of strong returns going forward would be greater.
Decumulators should be more than satisfied with these returns as long as they stayed away from commodities, didn't park their retirement assets in cash and followed a well conceived asset allocation/drawdown strategy. Most decumulators are retirees. The behavior of markets for the first several years of retirement are critical. The 65 year old who retired 5 years ago is today 70 years old - by the "rule of 72" the annualized 14.15% return on equities has doubled money in the stock market. A retiree could hardly ask for more! Most will find that they took a nice drawdown and today have more than they started with 5 years ago and yet are 5 years closer to the grim reaper.
What more could they ask for?
All three show up on the investment manager/financial planner's doorstep and the fact is only the first two can be helped unless the live for today person has had a revelation and has years to go before they want to build a nest egg or happily has been the beneficiary of an inheritance, won the lottery etc.
So what about the market for the accumulator and decumulator categories? Here are some market indices as reported by Schwab in their performance module. The returns are thru the close of business on 10/14/2016:
Market Index 3 months YTD 1 year 5 years
S&P 500 -0.9 6.17 9.30 14.15
MSCI EAFE 1.22 -.47 -1.05 5.56
Russell 2000 1.21 8.01 8.25 12.77
Barclay's Bond -0.50 5.08 3.84 3.10
Citi 3-mo. TB 0.07 0.20 0.21 0.08
S&P GSCI 1.60 7.72 -11.53 -13.54
Note that the 5 year number is an average annualized return. The S&P GSCI is an index of commodities produced by Goldman Sachs. The Citi 3-mo. TB (Treasury bill) return is a proxy for cash equivalent investments.
From one perspective the returns have been good for both the accumulator and the decumulator. They have been good for the accumulator because positive returns keep people in the market. On the other hand positive returns means the market is getting more pricey and sometimes gets investors to take more risk than they should. Accumulators would actually be better off if the returns were negative because then they could pick up shares at a lower price and the probability of strong returns going forward would be greater.
Decumulators should be more than satisfied with these returns as long as they stayed away from commodities, didn't park their retirement assets in cash and followed a well conceived asset allocation/drawdown strategy. Most decumulators are retirees. The behavior of markets for the first several years of retirement are critical. The 65 year old who retired 5 years ago is today 70 years old - by the "rule of 72" the annualized 14.15% return on equities has doubled money in the stock market. A retiree could hardly ask for more! Most will find that they took a nice drawdown and today have more than they started with 5 years ago and yet are 5 years closer to the grim reaper.
What more could they ask for?
Sunday, October 9, 2016
A Big Mistake
Over 20 years ago the bank I worked at was taken over by another bank. Companies are bought and sold all the time. This of course raises the stress level of employees, rumors swirl on who will be let go and who will stay. There is talk of promotions and everyone is focused on a potential reorganization and possible physical move. If you've been through this you know what I mean.
One of the outcomes typically is a short notice from Human Resources informing employees that the 401(k) will be terminated and that the employee has a number of options. They can roll over into the new company's 401(k), they can roll over to an IRA with a broker like Schwab or Vanguard, or they can can paid out a lump sum. Getting paid out a lump sum typically involves a penalty and income taxes.
The big mistake is taking the lump sum. Unfortunately, I saw most lower income employees seeing it as some type of windfall. Visions of a happy holiday season danced in their heads. They were happy to get this opportunity to take the lump sum distribution.
But look at the situation. Suppose an employee back then had $20,000 in his or her 401(k). Let's suppose the employee was 35 years old. They take it as a lump sum payment and pay a 10% early withdrawal penalty of $2,000 and income taxes of roughly 20% say so they get a check for $14,000. Wow! Happy dance time.
But fast forward 20 years and note that over the period a conservatively allocated 65% stock/35% bond portfolio more than quadrupled. The $20,000 today would be worth more than $80,000! The employee is now 55 years old and possibly faces retirement within 10 years - meaning that the $80,000 can potentially tack on quite a bit more. By the rule of 72 the portfolio only needs a return of 7.2%/year on average to double in 10 years.
This is a mistake that comes in many guises. Whenever there is a sum of money lying around there is a temptation to take it. It is like the person who is trying to quit smoking but just can't as long as there is cigarette nearby.
But time goes by and one day we'll all be facing that 65 year old birthday and then mistakes or not will be obvious.
One of the outcomes typically is a short notice from Human Resources informing employees that the 401(k) will be terminated and that the employee has a number of options. They can roll over into the new company's 401(k), they can roll over to an IRA with a broker like Schwab or Vanguard, or they can can paid out a lump sum. Getting paid out a lump sum typically involves a penalty and income taxes.
The big mistake is taking the lump sum. Unfortunately, I saw most lower income employees seeing it as some type of windfall. Visions of a happy holiday season danced in their heads. They were happy to get this opportunity to take the lump sum distribution.
But look at the situation. Suppose an employee back then had $20,000 in his or her 401(k). Let's suppose the employee was 35 years old. They take it as a lump sum payment and pay a 10% early withdrawal penalty of $2,000 and income taxes of roughly 20% say so they get a check for $14,000. Wow! Happy dance time.
But fast forward 20 years and note that over the period a conservatively allocated 65% stock/35% bond portfolio more than quadrupled. The $20,000 today would be worth more than $80,000! The employee is now 55 years old and possibly faces retirement within 10 years - meaning that the $80,000 can potentially tack on quite a bit more. By the rule of 72 the portfolio only needs a return of 7.2%/year on average to double in 10 years.
This is a mistake that comes in many guises. Whenever there is a sum of money lying around there is a temptation to take it. It is like the person who is trying to quit smoking but just can't as long as there is cigarette nearby.
But time goes by and one day we'll all be facing that 65 year old birthday and then mistakes or not will be obvious.
Sunday, October 2, 2016
How's the Market Doing?
When asked about how the market is doing people tend to respond with "it's pretty much going sideways". Really?
Mostly they focus on stocks which is understandable since stocks are the most volatile component of the markets over the short term. Still I think it is more appropriate to look at markets from a broader perspective.
For example, many investors follow an allocation of roughly 60% stocks/40% fixed income (bonds) and cash. This is a pretty conservative allocation even for those at the beginning of their retirement.
Here is Schwab's model for this particular allocation:
35% Large Cap Equity
10% Small Cap Equity
15% International
35% Bonds
5% Cash
Readers of this blog and many other investors know it is easy to get low cost index Funds to mirror this and similar allocations.
So how is this model doing? Year - to - date thru 9/30 it has total return of 5.89% and over the 12 months ended 9/30/2016 it has a total return of 10.69%. So the market is hardly going sideways and those who have stayed on the sidelines are falling behind.
I'm just the messenger so don't kill me. And I, along with everyone else, have no idea where the market is going next. I'm just reporting where we are.
Let's consider the results thus far for retirees. For retirees 4% is an important metric. It is the amount that can be withdrawn with an inflation adjustment and have concerns about running out of money be pretty much a non event.
Inflation over the past 12 months on the basis of the Personal Consumption Expenditures (PCE) price Index (the FOMC's preferred inflation measure) is running at 1.7% (ex Food & Energy) through the end of August.
Thus, the retiree who can achieve a return of 4% + 1.7% = 5.7% is right on target. Actually he or she is ahead a bit because they hit the target and they are one year closer to the grim reaper! I hate to put it like that but it is what it is!
In essence the bottom line is that they can end the year with the the same portfolio value in real terms after extracting their income need.
Just one final point on the question " do I have enough to retire?". As we have seen there has been a sharp rise in the stock market and bond prices from the depths reached in March 2009.
Understandably some people will look at their portfolios, consider Social Security and possibly throw in a pension or rental income, add it all up and conclude they have enough to retire. If you are in this boat I suggest you look at your "nest egg" and only count 80%. In other words take your income from this source at 4% times 80% of your egg. It just means you can withstand a decent size downturn and not be in a quandary. In 2000 and then again in early 2009 market downturns pushed some retirees out of retirement. One of the tricks in retirement is to make it past the first 5 or so years!
Mostly they focus on stocks which is understandable since stocks are the most volatile component of the markets over the short term. Still I think it is more appropriate to look at markets from a broader perspective.
For example, many investors follow an allocation of roughly 60% stocks/40% fixed income (bonds) and cash. This is a pretty conservative allocation even for those at the beginning of their retirement.
Here is Schwab's model for this particular allocation:
35% Large Cap Equity
10% Small Cap Equity
15% International
35% Bonds
5% Cash
Readers of this blog and many other investors know it is easy to get low cost index Funds to mirror this and similar allocations.
So how is this model doing? Year - to - date thru 9/30 it has total return of 5.89% and over the 12 months ended 9/30/2016 it has a total return of 10.69%. So the market is hardly going sideways and those who have stayed on the sidelines are falling behind.
I'm just the messenger so don't kill me. And I, along with everyone else, have no idea where the market is going next. I'm just reporting where we are.
Let's consider the results thus far for retirees. For retirees 4% is an important metric. It is the amount that can be withdrawn with an inflation adjustment and have concerns about running out of money be pretty much a non event.
Inflation over the past 12 months on the basis of the Personal Consumption Expenditures (PCE) price Index (the FOMC's preferred inflation measure) is running at 1.7% (ex Food & Energy) through the end of August.
Thus, the retiree who can achieve a return of 4% + 1.7% = 5.7% is right on target. Actually he or she is ahead a bit because they hit the target and they are one year closer to the grim reaper! I hate to put it like that but it is what it is!
In essence the bottom line is that they can end the year with the the same portfolio value in real terms after extracting their income need.
Just one final point on the question " do I have enough to retire?". As we have seen there has been a sharp rise in the stock market and bond prices from the depths reached in March 2009.
Understandably some people will look at their portfolios, consider Social Security and possibly throw in a pension or rental income, add it all up and conclude they have enough to retire. If you are in this boat I suggest you look at your "nest egg" and only count 80%. In other words take your income from this source at 4% times 80% of your egg. It just means you can withstand a decent size downturn and not be in a quandary. In 2000 and then again in early 2009 market downturns pushed some retirees out of retirement. One of the tricks in retirement is to make it past the first 5 or so years!
Sunday, September 25, 2016
A Black Swan?
Nassim Taleb popularized the idea of Black Swan events in his best selling books, "Fooled By Randomness" and "The Black Swan". These events are unpredictable and have significant effects on financial markets. Market participants are adept at constructing narratives in hind sight that make the events seem obvious. The 2008 housing crisis which produced the worst economic downturn since the Great Depression of the 1930s along with a market crash is an excellent recent example.
The key is that the event be totally unexpected. It can be either good or bad.
One candidate I believe that is out there at present is that the actions followed by Central Banks and the U.S. Federal Reserve will actually produce a well functioning global and U.S. economy. This is based on my watching the markets, reading about the markets and talking to investors. I have to say that I don't know of anyone who thinks that there aren't some serious bumps and bruises if not much worse in the near to intermediate future coming from following a zero interest rate and negative interest rate policy. I have to add that I believe this is so even for the Fed governors in their heart of hearts. Uncharted waters are scary
But, what if the economy ratchets up its growth rate to 3%, the unemployment rate drifts a bit lower in the U.S., tax collections reduce the deficit and the Federal Reserve has the Fed Funds rate at a more normal 3% rate say in 4 years? Wouldn't this qualify as a "Black Swan"?
And surely all those now predicting a sharp downturn immediately ahead would have no problem creating a narrative explaining how we got on the road to nirvana.
To be absolutely clear I don't expect this to happen. This is merely an academic exercise to keep us on our toes. To be sure, I'm in the camp of those who believe that manipulating the price of money or practically the price of anything is bad policy and distorts the system (i.e. creates bubbles) and eventually ends badly.
The key is that the event be totally unexpected. It can be either good or bad.
One candidate I believe that is out there at present is that the actions followed by Central Banks and the U.S. Federal Reserve will actually produce a well functioning global and U.S. economy. This is based on my watching the markets, reading about the markets and talking to investors. I have to say that I don't know of anyone who thinks that there aren't some serious bumps and bruises if not much worse in the near to intermediate future coming from following a zero interest rate and negative interest rate policy. I have to add that I believe this is so even for the Fed governors in their heart of hearts. Uncharted waters are scary
But, what if the economy ratchets up its growth rate to 3%, the unemployment rate drifts a bit lower in the U.S., tax collections reduce the deficit and the Federal Reserve has the Fed Funds rate at a more normal 3% rate say in 4 years? Wouldn't this qualify as a "Black Swan"?
And surely all those now predicting a sharp downturn immediately ahead would have no problem creating a narrative explaining how we got on the road to nirvana.
To be absolutely clear I don't expect this to happen. This is merely an academic exercise to keep us on our toes. To be sure, I'm in the camp of those who believe that manipulating the price of money or practically the price of anything is bad policy and distorts the system (i.e. creates bubbles) and eventually ends badly.
Sunday, September 18, 2016
Recent Data on Passive Versus Active
One of the most important decisions an investor can make is whether to go passive or active. Passive accepts the market return, active seeks to beat the market return.
I am in the camp that says most investors investing for retirement should go passive (see previous post of "Proposal"). This rests on the belief that capital markets are mostly efficient. This means that stock and bond prices rapidly reflect publicly available information.
Believing in efficient markets practically comes with the territory of being an economist. Economists are drilled in the idea that when you have low barriers to entry, abnormal (i.e. greater than market ) profits won't persist. Take this idea to the capital markets where billions of dollars are on the line and it is pretty straightforward.
But this isn't an intuitive notion for most people. They hear their friend made a killing selling beanie babies and they run out and garner an inventory only to watch them gather dust later in their basement.
So what does recent data on passive versus active show? One of the most anticipated reports of the year produced by Standard & Poor's is called the SPIVA report. This year, through 6/30/2016, 84.6% of large cap active managers underperformed the S&P 500 Index.
This means that if you bought SPY, the low cost index ETF, you outperformed 85 out of 100 managers for the year. For what it's worth, yearly performance is pretty much useless. Anything can happen in a year.
What is important is longer term performance because that is where costs that arise from active trading, management fees etc. come into play. The data shows that over the 5 years ended 6/30/2016 only 8% of active large cap managers performed better than the index. To break this down consider that if you had given 100 active large cap managers $1 million 5 years ago only 8 would have come back with better than index returns.
These results, along with the results of other market sectors, including "fixed income" are reported by Ryan Vlastelica in "How passive funds extended their dominance over actively managed rivals" /MarketWatch 9/15/2016.
There are various ways to try to beat the market. Some try to time the market, i.e. jump in when they think it is going up, jump out when then think it's going down. I call this the "hokey - pokey" approach to investing. And actually it amuses me. For example I was recently entertained by the mass exit called for after the Brexit vote. As we saw the market didn't fall off a cliff, instead it reached new records.
Another was to beat the market is to try and pick the best stocks. In this category I find especially interesting the so-called long/short Funds. If you think you can pick stocks then surely this proposition would interest you: study the stocks in the S&P 500 and short the 50 you dislike the most and with the proceeds buy equally weighted positions in the 50 you like the best.
Clearly, if you have any stock picking ability you would provide a superior return. Not only that but you should do well in any kind of market. This was, in fact, the pitch Funds following this approach presented. I know because I spent the first 20 years of my career investing for pension funds, endowments and other institutional investors. I heard the pitches.
How have they done you ask? William Baldwin, "Scary Results At Long-Short Equity Funds", 8/23/2016 Forbes provides some data. He says that Morningstar puts 133 publicly offered Funds in this category and that they returned 2%, average annualized return for 3 years ended 6/30/2016. The average stock index Fund returned 11.7%/year.
Is it really any wonder active funds are seeing huge outflows and index funds are seeing huge inflows. You don't need to be an economist to grasp that money flows from poorly performing high cost products to better performing low cost products.
I am in the camp that says most investors investing for retirement should go passive (see previous post of "Proposal"). This rests on the belief that capital markets are mostly efficient. This means that stock and bond prices rapidly reflect publicly available information.
Believing in efficient markets practically comes with the territory of being an economist. Economists are drilled in the idea that when you have low barriers to entry, abnormal (i.e. greater than market ) profits won't persist. Take this idea to the capital markets where billions of dollars are on the line and it is pretty straightforward.
But this isn't an intuitive notion for most people. They hear their friend made a killing selling beanie babies and they run out and garner an inventory only to watch them gather dust later in their basement.
So what does recent data on passive versus active show? One of the most anticipated reports of the year produced by Standard & Poor's is called the SPIVA report. This year, through 6/30/2016, 84.6% of large cap active managers underperformed the S&P 500 Index.
This means that if you bought SPY, the low cost index ETF, you outperformed 85 out of 100 managers for the year. For what it's worth, yearly performance is pretty much useless. Anything can happen in a year.
What is important is longer term performance because that is where costs that arise from active trading, management fees etc. come into play. The data shows that over the 5 years ended 6/30/2016 only 8% of active large cap managers performed better than the index. To break this down consider that if you had given 100 active large cap managers $1 million 5 years ago only 8 would have come back with better than index returns.
These results, along with the results of other market sectors, including "fixed income" are reported by Ryan Vlastelica in "How passive funds extended their dominance over actively managed rivals" /MarketWatch 9/15/2016.
There are various ways to try to beat the market. Some try to time the market, i.e. jump in when they think it is going up, jump out when then think it's going down. I call this the "hokey - pokey" approach to investing. And actually it amuses me. For example I was recently entertained by the mass exit called for after the Brexit vote. As we saw the market didn't fall off a cliff, instead it reached new records.
Another was to beat the market is to try and pick the best stocks. In this category I find especially interesting the so-called long/short Funds. If you think you can pick stocks then surely this proposition would interest you: study the stocks in the S&P 500 and short the 50 you dislike the most and with the proceeds buy equally weighted positions in the 50 you like the best.
Clearly, if you have any stock picking ability you would provide a superior return. Not only that but you should do well in any kind of market. This was, in fact, the pitch Funds following this approach presented. I know because I spent the first 20 years of my career investing for pension funds, endowments and other institutional investors. I heard the pitches.
How have they done you ask? William Baldwin, "Scary Results At Long-Short Equity Funds", 8/23/2016 Forbes provides some data. He says that Morningstar puts 133 publicly offered Funds in this category and that they returned 2%, average annualized return for 3 years ended 6/30/2016. The average stock index Fund returned 11.7%/year.
Is it really any wonder active funds are seeing huge outflows and index funds are seeing huge inflows. You don't need to be an economist to grasp that money flows from poorly performing high cost products to better performing low cost products.
Monday, September 12, 2016
A Proposal - Summary
This proposal's purpose is to give everyone at least a framework of how to go about building a nest egg for retirement, as presented in the previous 4 posts. Like many areas we have gone 90% of the way to handling a problem but then stop just short of wrapping it up.
The 401(k) and similar qualified plans are excellent for getting people to a successful retirement. The problem is many don't know how to use it. The purpose of the proposal is to fix that. As mentioned in previous posts if you know how to invest or have a different approach then go for it. Again, a caveat, if you are hell bent on beating the market by picking stocks or active Funds or timing the market all I can say is "good luck". The odds are against you.
Begin by emphasizing the importance of starting early and putting away at least 10% of every paycheck.
So, the proposal: start with an appropriate target date/life cycle/retirement date Fund . How to do this will be presented in a 15 minute video when you take your job. Secondly, once you reach $60,000 or so in your 401(k) switch to low cost index Funds with an appropriate asset allocation. Typically this would be somewhere around 70% stocks/30% bonds. Finally, when you reach the point where you are thinking of generating an income off of your portfolio consider creating a dividend stream by using bonds Funds and Dividend Funds and even individual dividend stocks.
The first two steps require very little time. The third is a bit more time consuming.
As explained in the previous 4 posts there is no need to switch at various points. If you have no interest and just want to stick with the life cycle approach you can do that. Or you can stay with the low cost, index Funds. The only reason to switch at various times is to lower the costs a bit. It is worth noting that directly investing in the dividend stocks can potentially be the most rewarding because you have opportunities for tax loss harvesting, judicially increasing yields oner time etc.
The bottom line is that this proposal provides a way to emphasize to workers that by following some very basic steps they can end up enjoying a nice retirement.
The 401(k) and similar qualified plans are excellent for getting people to a successful retirement. The problem is many don't know how to use it. The purpose of the proposal is to fix that. As mentioned in previous posts if you know how to invest or have a different approach then go for it. Again, a caveat, if you are hell bent on beating the market by picking stocks or active Funds or timing the market all I can say is "good luck". The odds are against you.
Begin by emphasizing the importance of starting early and putting away at least 10% of every paycheck.
So, the proposal: start with an appropriate target date/life cycle/retirement date Fund . How to do this will be presented in a 15 minute video when you take your job. Secondly, once you reach $60,000 or so in your 401(k) switch to low cost index Funds with an appropriate asset allocation. Typically this would be somewhere around 70% stocks/30% bonds. Finally, when you reach the point where you are thinking of generating an income off of your portfolio consider creating a dividend stream by using bonds Funds and Dividend Funds and even individual dividend stocks.
The first two steps require very little time. The third is a bit more time consuming.
As explained in the previous 4 posts there is no need to switch at various points. If you have no interest and just want to stick with the life cycle approach you can do that. Or you can stay with the low cost, index Funds. The only reason to switch at various times is to lower the costs a bit. It is worth noting that directly investing in the dividend stocks can potentially be the most rewarding because you have opportunities for tax loss harvesting, judicially increasing yields oner time etc.
The bottom line is that this proposal provides a way to emphasize to workers that by following some very basic steps they can end up enjoying a nice retirement.
Monday, September 5, 2016
A Proposal - Step 4
Ok...so to rehash what we have so far to get most people on track for a nice retirement: for your first job, assuming the company has a decent 401(k) just elect to put at least 10% away out of each paycheck and pick the Fund corresponding to the retirement date or life cycle or target date Fund. Forget about it, go to work and when it reaches $60,000 or so say switch to a well defined asset allocation using low cost index Funds.
How to do this can be presented by Human Resources on the first day of employment by using a short online video. Why can't Fund providers do this? Well, they can but they won't because they get far greater fees by getting Plan participants to use higher cost actively traded Funds that they switch around frequently.
The beauty of going target date Fund and then low cost Funds is that it gets over some formidable hurdles. First, many would be participants back off because there are so many choices. Economic theory has found that too many choices is actually not a good thing in many instances. Secondly, many would be participants just don't understand the process and that they are responsible for building their own nest egg. They think it takes time and expertise to do this. In fact, it runs itself once it is set up.
Now we come to the third and final phase. This is when you have reached the point where you need to generate an income off your nest egg. Note that at this point your goal has changed significantly from growing your nest egg to generating an income off of your nest egg.
There are some choices here. Today for example you can get approximately 5.5% off your nest egg by buying a single premium immediate pay annuity. This is an insurance product that pays a monthly income (or at whatever interval you pretty much request) and has the clear advantages of ensuring you never run out of money and not being subject to a possible sharp drop in the market. The big disadvantage is that you lose control of the money both for emergency needs and for leaving assets to heirs.
Another choice is to invest in Treasury Notes. At the present time the 10 year Treasury Note yields 1.6%, about in line with the rate of inflation. A big disadvantage in addition to the low yield is that the interest payment stays constant over the life of the Note. This means that the interest payment you receive over the next 10 years would stay the same. Assuming inflation rises this means you would be losing ground.
The third alternative is to create, in effect, your own annuity by using dividend stocks. For the retiree willing to spend some time at it there are numerous solid stocks that offer yields of 3% and higher. Furthermore, they have a history of increasing their yields. To get an idea of the stocks in this category just Google "dividend stocks" and you'll come up with all kinds of listings. Finance magazines such as Barron's, Kiplingers. Money etc. constantly provide lists of attractive dividend payers as well.
But what about the possibility of the market dropping? After all, at this point we are in retirement and as commenters like to say "retirees don't have much time for the market to recover after a downturn". This actually isn't too great an issue in my view if you frame the process appropriately.
Think about the first two alternatives: an annuity and a Treasury Note. In each instance we did the investment and then whatever happened to the market didn't matter. Think also about your Social Security. Does a market downturn have any impact on Social Security?
The point here is that once you have invested the main concern is with your income stream not with the market value of the portfolio. Odds are that with some basic principles your income stream should increase as your stocks increase their dividends. If over time your portfolio rises in value it's basically gravy. If it drops it is no big deal, again as long as your income stream holds up.
What are the basic principles? First, limit the size of specific company holdings to 5% of total assets. This limits the impact of a negative event. Secondly, be careful about industry diversification. For example, choose Verizon or AT&T but not both. They are in the same industry. Choose one or two energy companies, utility companies, banks etc. If you extend to riskier companies invest 2.5% of total assets. You'll find business development companies that offer, for example, double digit yields. Always remember that extra yield means extra risk.
A negative for this approach is that it takes time. The first two approaches ran themselves. Not the dividend portfolio. But some retirees find that creating a dividend portfolio and managing it is a great "hobby" in retirement. As you get into it you find numerous opportunities, on an ongoing basis, to increase yield and improve the portfolio. The bottom line is that it can pay off nicely for the retiree willing to put in the effort.
How to do this can be presented by Human Resources on the first day of employment by using a short online video. Why can't Fund providers do this? Well, they can but they won't because they get far greater fees by getting Plan participants to use higher cost actively traded Funds that they switch around frequently.
The beauty of going target date Fund and then low cost Funds is that it gets over some formidable hurdles. First, many would be participants back off because there are so many choices. Economic theory has found that too many choices is actually not a good thing in many instances. Secondly, many would be participants just don't understand the process and that they are responsible for building their own nest egg. They think it takes time and expertise to do this. In fact, it runs itself once it is set up.
Now we come to the third and final phase. This is when you have reached the point where you need to generate an income off your nest egg. Note that at this point your goal has changed significantly from growing your nest egg to generating an income off of your nest egg.
There are some choices here. Today for example you can get approximately 5.5% off your nest egg by buying a single premium immediate pay annuity. This is an insurance product that pays a monthly income (or at whatever interval you pretty much request) and has the clear advantages of ensuring you never run out of money and not being subject to a possible sharp drop in the market. The big disadvantage is that you lose control of the money both for emergency needs and for leaving assets to heirs.
Another choice is to invest in Treasury Notes. At the present time the 10 year Treasury Note yields 1.6%, about in line with the rate of inflation. A big disadvantage in addition to the low yield is that the interest payment stays constant over the life of the Note. This means that the interest payment you receive over the next 10 years would stay the same. Assuming inflation rises this means you would be losing ground.
The third alternative is to create, in effect, your own annuity by using dividend stocks. For the retiree willing to spend some time at it there are numerous solid stocks that offer yields of 3% and higher. Furthermore, they have a history of increasing their yields. To get an idea of the stocks in this category just Google "dividend stocks" and you'll come up with all kinds of listings. Finance magazines such as Barron's, Kiplingers. Money etc. constantly provide lists of attractive dividend payers as well.
But what about the possibility of the market dropping? After all, at this point we are in retirement and as commenters like to say "retirees don't have much time for the market to recover after a downturn". This actually isn't too great an issue in my view if you frame the process appropriately.
Think about the first two alternatives: an annuity and a Treasury Note. In each instance we did the investment and then whatever happened to the market didn't matter. Think also about your Social Security. Does a market downturn have any impact on Social Security?
The point here is that once you have invested the main concern is with your income stream not with the market value of the portfolio. Odds are that with some basic principles your income stream should increase as your stocks increase their dividends. If over time your portfolio rises in value it's basically gravy. If it drops it is no big deal, again as long as your income stream holds up.
What are the basic principles? First, limit the size of specific company holdings to 5% of total assets. This limits the impact of a negative event. Secondly, be careful about industry diversification. For example, choose Verizon or AT&T but not both. They are in the same industry. Choose one or two energy companies, utility companies, banks etc. If you extend to riskier companies invest 2.5% of total assets. You'll find business development companies that offer, for example, double digit yields. Always remember that extra yield means extra risk.
A negative for this approach is that it takes time. The first two approaches ran themselves. Not the dividend portfolio. But some retirees find that creating a dividend portfolio and managing it is a great "hobby" in retirement. As you get into it you find numerous opportunities, on an ongoing basis, to increase yield and improve the portfolio. The bottom line is that it can pay off nicely for the retiree willing to put in the effort.
Monday, August 29, 2016
A Proposal - Step 3
Ok...so here's the deal. We started our career and recognize that we are responsible for our own retirement. But we've had no training or education on how to achieve that retirement. So, we start by saving at least 10% of our gross income and doing that by putting it into our company 401(k).The specific investment we select is the retirement date Fund corresponding to when we are in our mid 60s.
And then we go to work, live our life and get promoted and maybe get bonuses. Some people of course will find it difficult to save at least 10%. It is very easy to have your lifestyle adjust to whatever income you have. Interestingly there are professional athletes raking in millions who for the life of them cannot apparently save a cent.
I have found that if you fortunately are in a position to get raises and promotions as time goes by and don't automatically increase your lifestyle each time then you should be able easily to meet the 10% and higher saving goal.
Anyways...get it done. Sit down and have a face-to-face with your 65 year old self and let him or her know that you are doing it for them. While you're at it motivate yourself by recognizing you are doing it for the kids. The last thing they want is a broke mom and pop when they are trying to get their family going.
So, we're saving, time goes by, as it always has, and we reach a point where the 401(k) is starting to reach a decent size. For the sake of argument we can take this to be $80,000 or so. The next phase comes into play. At this point you may want to consider investing in individual Funds within your 401(k). This should save you .50% or so annually. This may not seem like a lot but when you consider the savings over 25 to 30 years it becomes meaningful. And the beauty of it is that it isn't difficult.
As an aside you don't have to do it. If you deem your efforts better used in other areas then stick with the target date Fund approach.
So, how do you use individual Funds? Take a look at your 401(k) Fund offerings. They hopefully include low cost index Funds. For the sake of argument assume that Fidelity is your 401(k) Fund advisor. Assume as well you have been investing in the Fidelity Freedom 2050 Fund, ticker symbol FFFHX. If you go to www.morningstar.com and put the ticker symbol in the quote box you find that FFFHX has an annual expense of .77%.
The new approach of using individual Funds would include FUSEX, an S&P 500 Fund (.09%), FSGUX, a global ex U.S. Fund (.18%), FBIDX an Index bond Fund (.15%), and FSSPX, a small cap index Fund (.19%). The respective annual fees for the Funds are shown in parentheses.
You can use these 4 Funds to set up your asset allocation. For example, if you are 40 years old you may decide to allocate 70% to stocks and 30% to bonds if you are fairly comfortable with some portfolio volatility. If not, reduce the stock allocation to 60%.
For your stock position you may want to have 15% in the global Fund, FSGUX, and 5% in the small cap Fund, FSSPX. The global Fund gives diversification and exposure at the present time in a part of the market that hasn't done well. The small cap Fund increases volatility a bit in a sector that has provided higher returns.
You'll undoubtedly notice that this simplifies your investment setup. The 2050 Fund is comprised of many more Funds. Which is better? Wouldn't the greater complexity and more Funds in the 2050 Fund mean better performance? Actually, we don't know unless we have the proverbial "crystal ball".
The simpler structure does however mean that it is easier to understand and analyze and the fact that it saves approximately .5%/year means that over the long term it has the odds highly in its favor to meaningfully outperform.
To recap: on day 1 of starting your career you elect to have at least 10% of each paycheck go into the target date Fund offered by your 401(k). After a few years go by and it has reached a sizable amount consider investing in individual Funds in order to reduce the annual expenses. This will take you to your mid 60s at which point your goal shifts meaningfully from getting growth of your portfolio to generating an income from your portfolio. That will be the subject of the next post.
Let me reemphasize that you don't obviously have to follow this approach. You may feel you are a great stock picker. You may believe you can time the market. If so, go for it with my blessing. Just understand that the odds are extremely high that you are wrong and that it could be very costly learning that fact.
And then we go to work, live our life and get promoted and maybe get bonuses. Some people of course will find it difficult to save at least 10%. It is very easy to have your lifestyle adjust to whatever income you have. Interestingly there are professional athletes raking in millions who for the life of them cannot apparently save a cent.
I have found that if you fortunately are in a position to get raises and promotions as time goes by and don't automatically increase your lifestyle each time then you should be able easily to meet the 10% and higher saving goal.
Anyways...get it done. Sit down and have a face-to-face with your 65 year old self and let him or her know that you are doing it for them. While you're at it motivate yourself by recognizing you are doing it for the kids. The last thing they want is a broke mom and pop when they are trying to get their family going.
So, we're saving, time goes by, as it always has, and we reach a point where the 401(k) is starting to reach a decent size. For the sake of argument we can take this to be $80,000 or so. The next phase comes into play. At this point you may want to consider investing in individual Funds within your 401(k). This should save you .50% or so annually. This may not seem like a lot but when you consider the savings over 25 to 30 years it becomes meaningful. And the beauty of it is that it isn't difficult.
As an aside you don't have to do it. If you deem your efforts better used in other areas then stick with the target date Fund approach.
So, how do you use individual Funds? Take a look at your 401(k) Fund offerings. They hopefully include low cost index Funds. For the sake of argument assume that Fidelity is your 401(k) Fund advisor. Assume as well you have been investing in the Fidelity Freedom 2050 Fund, ticker symbol FFFHX. If you go to www.morningstar.com and put the ticker symbol in the quote box you find that FFFHX has an annual expense of .77%.
The new approach of using individual Funds would include FUSEX, an S&P 500 Fund (.09%), FSGUX, a global ex U.S. Fund (.18%), FBIDX an Index bond Fund (.15%), and FSSPX, a small cap index Fund (.19%). The respective annual fees for the Funds are shown in parentheses.
You can use these 4 Funds to set up your asset allocation. For example, if you are 40 years old you may decide to allocate 70% to stocks and 30% to bonds if you are fairly comfortable with some portfolio volatility. If not, reduce the stock allocation to 60%.
For your stock position you may want to have 15% in the global Fund, FSGUX, and 5% in the small cap Fund, FSSPX. The global Fund gives diversification and exposure at the present time in a part of the market that hasn't done well. The small cap Fund increases volatility a bit in a sector that has provided higher returns.
You'll undoubtedly notice that this simplifies your investment setup. The 2050 Fund is comprised of many more Funds. Which is better? Wouldn't the greater complexity and more Funds in the 2050 Fund mean better performance? Actually, we don't know unless we have the proverbial "crystal ball".
The simpler structure does however mean that it is easier to understand and analyze and the fact that it saves approximately .5%/year means that over the long term it has the odds highly in its favor to meaningfully outperform.
To recap: on day 1 of starting your career you elect to have at least 10% of each paycheck go into the target date Fund offered by your 401(k). After a few years go by and it has reached a sizable amount consider investing in individual Funds in order to reduce the annual expenses. This will take you to your mid 60s at which point your goal shifts meaningfully from getting growth of your portfolio to generating an income from your portfolio. That will be the subject of the next post.
Let me reemphasize that you don't obviously have to follow this approach. You may feel you are a great stock picker. You may believe you can time the market. If so, go for it with my blessing. Just understand that the odds are extremely high that you are wrong and that it could be very costly learning that fact.
Monday, August 22, 2016
A Proposal - Step 2
The purpose of this proposal is to suggest an investment approach to get people on the right path for retirement. As pointed out in the last post we are now responsible for our own retirement. Unfortunately many people shy away from investing even when they have access to good 401(k)s simply because they don't know how to manage money or the basics of investing. Sadly, real world knowledge such as this isn't typically taught in school.
As pointed out in the last post, investing, if taught at all, is presented as an exercise in analyzing individual stocks and picking stocks to trade. This plays into the hands of Wall Street but is not helpful for the long term investor looking at a 401(k) facing a multitude of mutual Funds or ETFs to invest in on an ongoing basis.
So, Step 1 was straightforward - seek the so-called "retirement date Fund" to start with. Go with a retirement date fund until your assets build to a level where it could make sense to use individual Funds. So for example, if your expected retirement date is 2040 (this isn't something to get hung up on, just pick a date where you are near your mid 60s in age) and you are employed by the government and therefore participate in the Thrift Savings Plan (TSP) select their "Lifecycle Fund" L2040. If Fidelity is your 401(k) provider choose their Freedom 2040 Freedom Fund with the ticker symbol FFFFX. If Schwab is your plan provider pick the Schwab target Fund with the ticker symbol SWERX.
If you can't find the Fund in your 401(k) corresponding to a retirement date Fund ask your human resources department where it is and how you sign up for it.
Once you have picked a Fund allocate at least 10% of your gross income to the Fund and the contribution will be made out of every paycheck and allocated in an appropriate manner. Finally, forget about it. Spend your time building your job skills, having fun with your family and doing other important stuff.
You could go with this throughout your work career. I suggest however that once your account nears 6 figures you think about investing in individual Funds. This is step 2. Typically you'll go with step 2 for at least a couple of decades and by investing in individual Funds you'll lower the cost. It may not seem like a lot but over a number of years the cost savings can be meaningful.
To begin with just focus on index funds. These funds match a particular part of the market. They are not actively traded in an effort to beat the market. Research shows that trying to beat the market is a futile effort. Upwards of 80% of managers who try to beat the market over the long term fail.
Secondly, decide on an asset allocation. There are a number of ways to do this and the critical steps are to consider your investment horizon, your goals, and your tolerance for volatility. At this point you have some experience under your belt and realize that the market can be pretty volatile over the short run but that sticking with an investment approach as you did with the target date Fund pays off.
In terms of investment horizon age is most important. If, for example, you are 40 years old then your nest egg funds won't start to be drawn down for 25 years and will be drawn down for a number of years after that. This suggests a fairly decent percentage invested in stocks with a realization again that the greater the stock exposure the greater the volatility.
So, just as an example, a forty year old could consider a 70% stock/30% bond allocation as a baseline. If a goal is to leave assets to heirs or take a shot at retiring early the percentage in stocks could be raised. On the other hand if the goal is to be absolutely sure of retirement in your early 60s you could lower the percentage in stocks.
Thinking through goals and desired lifestyles are important. Always keep in mind that the more you save today the more choices you will have down the road. The more you save the more your future self will appreciate your today self!
The next post will give a bit more detail on Step 2 and lead into the final step.
As pointed out in the last post, investing, if taught at all, is presented as an exercise in analyzing individual stocks and picking stocks to trade. This plays into the hands of Wall Street but is not helpful for the long term investor looking at a 401(k) facing a multitude of mutual Funds or ETFs to invest in on an ongoing basis.
So, Step 1 was straightforward - seek the so-called "retirement date Fund" to start with. Go with a retirement date fund until your assets build to a level where it could make sense to use individual Funds. So for example, if your expected retirement date is 2040 (this isn't something to get hung up on, just pick a date where you are near your mid 60s in age) and you are employed by the government and therefore participate in the Thrift Savings Plan (TSP) select their "Lifecycle Fund" L2040. If Fidelity is your 401(k) provider choose their Freedom 2040 Freedom Fund with the ticker symbol FFFFX. If Schwab is your plan provider pick the Schwab target Fund with the ticker symbol SWERX.
If you can't find the Fund in your 401(k) corresponding to a retirement date Fund ask your human resources department where it is and how you sign up for it.
Once you have picked a Fund allocate at least 10% of your gross income to the Fund and the contribution will be made out of every paycheck and allocated in an appropriate manner. Finally, forget about it. Spend your time building your job skills, having fun with your family and doing other important stuff.
You could go with this throughout your work career. I suggest however that once your account nears 6 figures you think about investing in individual Funds. This is step 2. Typically you'll go with step 2 for at least a couple of decades and by investing in individual Funds you'll lower the cost. It may not seem like a lot but over a number of years the cost savings can be meaningful.
To begin with just focus on index funds. These funds match a particular part of the market. They are not actively traded in an effort to beat the market. Research shows that trying to beat the market is a futile effort. Upwards of 80% of managers who try to beat the market over the long term fail.
Secondly, decide on an asset allocation. There are a number of ways to do this and the critical steps are to consider your investment horizon, your goals, and your tolerance for volatility. At this point you have some experience under your belt and realize that the market can be pretty volatile over the short run but that sticking with an investment approach as you did with the target date Fund pays off.
In terms of investment horizon age is most important. If, for example, you are 40 years old then your nest egg funds won't start to be drawn down for 25 years and will be drawn down for a number of years after that. This suggests a fairly decent percentage invested in stocks with a realization again that the greater the stock exposure the greater the volatility.
So, just as an example, a forty year old could consider a 70% stock/30% bond allocation as a baseline. If a goal is to leave assets to heirs or take a shot at retiring early the percentage in stocks could be raised. On the other hand if the goal is to be absolutely sure of retirement in your early 60s you could lower the percentage in stocks.
Thinking through goals and desired lifestyles are important. Always keep in mind that the more you save today the more choices you will have down the road. The more you save the more your future self will appreciate your today self!
The next post will give a bit more detail on Step 2 and lead into the final step.
Monday, August 15, 2016
A Proposal
Here is the dilemma: we are responsible for our own retirement but no one has taught us how to build a nest egg. Thus, we are at the mercy of the financial services industry which gladly provides the service and in the process takes a huge chunk of our nest egg and produces poor performance.
Not surprisingly many people avoid the responsibility of planning for their retirement until it is too late. In many instances people even pass up the opportunity for the 401(k) company match because they just don't know what to do. In other instances they wade into the company 401(k) and see a bewildering choice of Funds and subsequently back off bewildered.
If the subject of investing is taught at all in school it is taught by those who know little of the subject. They typically will use materials provided by the financial services industry and look at investing as a stock picking exercise. They will present a basic method of valuation based on P/E ratios etc. and encouraged to research stocks and trade the stocks. Many times this presented as a game. This of course is what the industry wants. If the industry could turn of us into day traders it would be exactly what they want.
So here is a proposed approach to teaching investing for retirement. I suggest it be presented by human resources departments when young people start their career or whenever they have the opportunity to participate in a 401(k) type vehicle. The approach isn't set in concrete for every single investor. If you think you're the next Warren Buffett and believe you are a great stock picker then go for it. If you want to trade your 401(k) aggressively to try to hit a homerun go for it. If you want to snub your nose at diversification principles go for it. Just understand that instead of hitting the ball in the upper deck you are more likely to strike out.
If instead you take Aesop's advice and go the route of the tortoise as presented here and are patient the odds are high that you will achieve the retirement dreams you seek.
Again this is a simple approach for most nest egg builders.
Begin by looking at your company 401(k) for so-called "retirement date funds" or "life cycle funds". They typically have a year attached to their name - this is the year of expected retirement. For example, a retirement date Fund might be named "Fund 2035". This would be for employees expected to retire in approximately 20 years. This would be you for example if you are in your mid 40s.
In fact, many 401(k)s automatically opt in new employees and the Fund they go into is the appropriate retirement date fund.
Check the retirement date fund's expense ratio. This expense is charged every year. It shouldn't be more than .3%. So, find the Fund that is closest to when you expect to retire and put 100% of your 401(k) contributions into it. You should save at least 10% of your gross income into your 401(k). More would be better. The more you save now the more choices you have down the road.
So with that simple step you're on the right path. By selecting a retirement date/life cycle type fund your asset allocation is handled for you. This basically is the percentage invested in stocks,bonds, international stocks etc. Your job now is to go to work on your career, get promoted build your human capital and even enjoy your family. Your investments are on auto pilot and doing their thing.
FAQ 1: What if the market drops and my account goes down?
First off you shouldn't be watching it that closely because you are working on getting promoted, enjoying your family etc. But still know this: a falling market is good because it enables you to buy more shares of the target date fund out of each paycheck. Always remember this: what you care about is where the market is years from now when you retire.
FAQ 2: What if I can't save at least 10%.
Make adjustments. Take another job, hold back on vacation expenses, buy a lesser car etc.Do what you have to do. The 10% is for your future self! Think about this: if you can't do at least 10% then it is likely you will be a burden to your kids when they are in their prime years of trying to build a family.
The next post will go step 2 on the transition to the next step once your 401(k) gets sizable.
Not surprisingly many people avoid the responsibility of planning for their retirement until it is too late. In many instances people even pass up the opportunity for the 401(k) company match because they just don't know what to do. In other instances they wade into the company 401(k) and see a bewildering choice of Funds and subsequently back off bewildered.
If the subject of investing is taught at all in school it is taught by those who know little of the subject. They typically will use materials provided by the financial services industry and look at investing as a stock picking exercise. They will present a basic method of valuation based on P/E ratios etc. and encouraged to research stocks and trade the stocks. Many times this presented as a game. This of course is what the industry wants. If the industry could turn of us into day traders it would be exactly what they want.
So here is a proposed approach to teaching investing for retirement. I suggest it be presented by human resources departments when young people start their career or whenever they have the opportunity to participate in a 401(k) type vehicle. The approach isn't set in concrete for every single investor. If you think you're the next Warren Buffett and believe you are a great stock picker then go for it. If you want to trade your 401(k) aggressively to try to hit a homerun go for it. If you want to snub your nose at diversification principles go for it. Just understand that instead of hitting the ball in the upper deck you are more likely to strike out.
If instead you take Aesop's advice and go the route of the tortoise as presented here and are patient the odds are high that you will achieve the retirement dreams you seek.
Again this is a simple approach for most nest egg builders.
Begin by looking at your company 401(k) for so-called "retirement date funds" or "life cycle funds". They typically have a year attached to their name - this is the year of expected retirement. For example, a retirement date Fund might be named "Fund 2035". This would be for employees expected to retire in approximately 20 years. This would be you for example if you are in your mid 40s.
In fact, many 401(k)s automatically opt in new employees and the Fund they go into is the appropriate retirement date fund.
Check the retirement date fund's expense ratio. This expense is charged every year. It shouldn't be more than .3%. So, find the Fund that is closest to when you expect to retire and put 100% of your 401(k) contributions into it. You should save at least 10% of your gross income into your 401(k). More would be better. The more you save now the more choices you have down the road.
So with that simple step you're on the right path. By selecting a retirement date/life cycle type fund your asset allocation is handled for you. This basically is the percentage invested in stocks,bonds, international stocks etc. Your job now is to go to work on your career, get promoted build your human capital and even enjoy your family. Your investments are on auto pilot and doing their thing.
FAQ 1: What if the market drops and my account goes down?
First off you shouldn't be watching it that closely because you are working on getting promoted, enjoying your family etc. But still know this: a falling market is good because it enables you to buy more shares of the target date fund out of each paycheck. Always remember this: what you care about is where the market is years from now when you retire.
FAQ 2: What if I can't save at least 10%.
Make adjustments. Take another job, hold back on vacation expenses, buy a lesser car etc.Do what you have to do. The 10% is for your future self! Think about this: if you can't do at least 10% then it is likely you will be a burden to your kids when they are in their prime years of trying to build a family.
The next post will go step 2 on the transition to the next step once your 401(k) gets sizable.
Tuesday, August 9, 2016
Comparing Apples to Oranges
A well known dismissal of an argument is the claim that one is comparing "apples to oranges". I came across this a couple of weeks ago in an article that claimed comparing dividend paying stocks to bonds is an "apples to oranges" comparison. Unfortunately I didn't write down the article so can't quote it directly.
As a past long time Economics instructor I am always amused when I see this "apples to oranges" phrase invoked. As it happens most Economics instructors compare apples to oranges in their microeconomics class when teaching the concept of substitute goods.
Simply, one can imagine the housewife or househusband pushing the grocery cart and noticing that the price of apples has risen and the price of oranges has fallen. What will they do? How will this affect demand and hence price?
The implication for dividend stocks and bonds is straightforward. At the margin, investors view the 10 year Treasury and dividend stocks as substitute goods in the world of needing to generate an income stream. Drive up the yield on dividend stocks and drive down the yield on the 10 year Treasury note and what do you think investors will throw into their shopping cart? What do you think will happen to prices.
It interests me considerably that so many market gurus have totally missed this market. As cited in Barron's this past weekend, Gundlach, head of DoubleLine Capital and the new "bond king" said "sell everything", Druckenmiller, Soros, and even Carl Icahn have been seriously negative on stocks. After the brexit vote the market was supposed to fall off a cliff. And yet it didn't, instead it set new record highs.
Now I'm not claiming I know where the market is headed but the fact is that to this point these great investors have missed a sharp upturn and one has to question what they are missing.
Maybe the apples to oranges comparison above has something to do with it, especially when on a daily basis we have thousands of baby boomers turning 65 and struggling to produce an income stream, as noted above.
Other thoughts have also crossed my mind as I listen to some prominent strategists. leading the biggest investment banks in the country present the bearish argument on CNBC. Their wailing and gnashing of teeth over China slowing, anemic corporate profits, and even the economy failing to respond to an aggressive Federal Reserve are well known.
But what if we step back a few years and I presented you with the proverbial crystal ball which showed a scenario with oil prices below $50.barrel, a 0.5% federal funds rate, a 10 year Treasury note yield of 1.5%, an unemployment rate below 5%, and inflation below the Fed's target? What if the crystal ball also showed that the U.S. economy was the best in the world and that the investment climate in most of the rest of the world was scary.
Some people foreseeing this in the crystal ball would have said sell everything that isn't tied down and put it into the market. Yet this has been the scenario we have seen unfold and again the best minds in the market have totally missed it to this point.
To me Bogle's observation that he has never known anyone or known anyone who has known anyone who can predict the market is apt here.
As a past long time Economics instructor I am always amused when I see this "apples to oranges" phrase invoked. As it happens most Economics instructors compare apples to oranges in their microeconomics class when teaching the concept of substitute goods.
Simply, one can imagine the housewife or househusband pushing the grocery cart and noticing that the price of apples has risen and the price of oranges has fallen. What will they do? How will this affect demand and hence price?
The implication for dividend stocks and bonds is straightforward. At the margin, investors view the 10 year Treasury and dividend stocks as substitute goods in the world of needing to generate an income stream. Drive up the yield on dividend stocks and drive down the yield on the 10 year Treasury note and what do you think investors will throw into their shopping cart? What do you think will happen to prices.
It interests me considerably that so many market gurus have totally missed this market. As cited in Barron's this past weekend, Gundlach, head of DoubleLine Capital and the new "bond king" said "sell everything", Druckenmiller, Soros, and even Carl Icahn have been seriously negative on stocks. After the brexit vote the market was supposed to fall off a cliff. And yet it didn't, instead it set new record highs.
Now I'm not claiming I know where the market is headed but the fact is that to this point these great investors have missed a sharp upturn and one has to question what they are missing.
Maybe the apples to oranges comparison above has something to do with it, especially when on a daily basis we have thousands of baby boomers turning 65 and struggling to produce an income stream, as noted above.
Other thoughts have also crossed my mind as I listen to some prominent strategists. leading the biggest investment banks in the country present the bearish argument on CNBC. Their wailing and gnashing of teeth over China slowing, anemic corporate profits, and even the economy failing to respond to an aggressive Federal Reserve are well known.
But what if we step back a few years and I presented you with the proverbial crystal ball which showed a scenario with oil prices below $50.barrel, a 0.5% federal funds rate, a 10 year Treasury note yield of 1.5%, an unemployment rate below 5%, and inflation below the Fed's target? What if the crystal ball also showed that the U.S. economy was the best in the world and that the investment climate in most of the rest of the world was scary.
Some people foreseeing this in the crystal ball would have said sell everything that isn't tied down and put it into the market. Yet this has been the scenario we have seen unfold and again the best minds in the market have totally missed it to this point.
To me Bogle's observation that he has never known anyone or known anyone who has known anyone who can predict the market is apt here.
Tuesday, June 21, 2016
Some Great Free Sources for Market Information
This morning I had work to do on a piece I was writing plus I wanted to follow Draghi's 9 am (EST) speech to the European Parliament on Brexit - Britain's decision to go or stay with respect to the European Union. Brexit of course is the most important event currently impacting global markets and has the potential, according to experts, to significantly roil markets, depending on the outcome of the vote.
So, how to follow events and work on the computer at the same time? The resource I use most often is Bloomberg TV available at http://www.bloomberg.com/live. I like the fact that there is no sign up and it can be brought up fast. And it is free!
Try it - I think you will like it. If you want to follow markets at the same time as you listen to Bloomberg TV you might want to reduce Bloomberg so you can still listen (I'm listening to Draghi as I type this) and bring up the futures page on MarketWatch http://www.marketwatch.com/. For those interested this can reveal market impacts of events in real time.
I will bring these resources up again later today as I follow Yellen's Congressional testimony. I hope you find these resources as useful as I do.
So, how to follow events and work on the computer at the same time? The resource I use most often is Bloomberg TV available at http://www.bloomberg.com/live. I like the fact that there is no sign up and it can be brought up fast. And it is free!
Try it - I think you will like it. If you want to follow markets at the same time as you listen to Bloomberg TV you might want to reduce Bloomberg so you can still listen (I'm listening to Draghi as I type this) and bring up the futures page on MarketWatch http://www.marketwatch.com/. For those interested this can reveal market impacts of events in real time.
I will bring these resources up again later today as I follow Yellen's Congressional testimony. I hope you find these resources as useful as I do.
Tuesday, May 3, 2016
Research on 60/40 Portfolio
Two points: we are wired to think short term, and investment research is typically too abstract and/or complicated to make basic points to the average investor.
Here is a nice succinct piece that shows results for a portofolio going back to 1926 comprised of 60% stocks/40% bonds (as represented by the 10-year Treasury):
What Can a 60/40 Portfolio Deliver?
by The Investment Scientist Michael Zhuang.
The results show the hugely important bottom line that the worst 10-year period was +1.8%/year. Think about this: if you are 75 years old or less, you probably have an investment horizon that is at least 10 years long. Most people, of course, have a considerably longer horizon and absolutely need portfolio growth!
Here is a nice succinct piece that shows results for a portofolio going back to 1926 comprised of 60% stocks/40% bonds (as represented by the 10-year Treasury):
What Can a 60/40 Portfolio Deliver?
by The Investment Scientist Michael Zhuang.
The results show the hugely important bottom line that the worst 10-year period was +1.8%/year. Think about this: if you are 75 years old or less, you probably have an investment horizon that is at least 10 years long. Most people, of course, have a considerably longer horizon and absolutely need portfolio growth!
Thursday, April 14, 2016
My 2 Cents on Active versus Passive and Tony Robbin's "Money"
I'm working my way through Money, Master The Game by self-help guru and motivator supreme Tony Robbins.
One claim he continually makes is that passive management, using low-cost indexes, beats active managers who try to time the market and/or pick stocks, 96% of the time.
I think most people would agree that Tony Robbins is an exaggerator of the highest degree; and this, in my opinion, is an example of it.
Interestingly, there is no definitive percentage of active management underperformance. When people throw out a number, they are basically referring to an average of numerous studies using various approaches. Whether active managers can beat the market has been studied by academics, i.e. non-partisan researchers, for various time periods, various asset classes, and even for different countries.
My belief, from studying the results, is that passive wins 70% to 80% of the time over longer periods after all costs are taken into account. If this is closer to the truth, then there are a fairly large number of managers and individuals beating the market by actively investing. For every 1,000 investors in this category, 200 to 300 fall in this special group.
But, still the odds obviously favor the passive approach for most investors who are saving for their retirement.
I break it down to simple terms when I explain this to people trying to get to a successful retirement. I say the active versus passive decision is like trying to draw a blue ball out of an urn that contains 200 to 300 blue balls and 700 to 800 red balls. Is this what most investors want to attempt when it comes to their nest egg?
Another point to understand, that Tony Robbins I think misses, is that many people who have underperformed just don't know it and actually believe they are doing well. Consider that a simple 65% stocks/35% bonds portfolio more than quadrupled over the past 20 years. For someone whose manager has tripled their assets over this period, he/she will likely feel they have done well. In other words, they are clueless how much their manager has taken in fees and/or underperformed! Probably they will go around touting their manager as a superior investment manager!
Keep in mind that there are always people who break the rules and win big. In one of my favorite books, Rocket Boys, the memoir by Homer Hickam, the mother put every last cent in Johnson & Johnson stock because she saw all the kids in the neighborhood constantly needing bandaids etc. for their recurring scrapes. She undoubtedly would look befuddled at the mention of diversification. But her one stock approach bought her a nice place in Myrtle Beach!
A final point made in this ongoing debate is on the failure of superior performance to persist. This means that picking the 200 to 300 market beaters over the last 10 years is futile. What is generally missed, however, is that some percentage of the underperformers from the first 10 years will outperform by such an extent over the next 10 years that they will be superior performers over the 20 years! Like zombies they come back!
Other than the irksome (to me) percentage, Tony Robbin's book is interesting albeit way too long and too much of a pump-it-up infomercial for my tastes.
One claim he continually makes is that passive management, using low-cost indexes, beats active managers who try to time the market and/or pick stocks, 96% of the time.
I think most people would agree that Tony Robbins is an exaggerator of the highest degree; and this, in my opinion, is an example of it.
Interestingly, there is no definitive percentage of active management underperformance. When people throw out a number, they are basically referring to an average of numerous studies using various approaches. Whether active managers can beat the market has been studied by academics, i.e. non-partisan researchers, for various time periods, various asset classes, and even for different countries.
My belief, from studying the results, is that passive wins 70% to 80% of the time over longer periods after all costs are taken into account. If this is closer to the truth, then there are a fairly large number of managers and individuals beating the market by actively investing. For every 1,000 investors in this category, 200 to 300 fall in this special group.
But, still the odds obviously favor the passive approach for most investors who are saving for their retirement.
I break it down to simple terms when I explain this to people trying to get to a successful retirement. I say the active versus passive decision is like trying to draw a blue ball out of an urn that contains 200 to 300 blue balls and 700 to 800 red balls. Is this what most investors want to attempt when it comes to their nest egg?
Another point to understand, that Tony Robbins I think misses, is that many people who have underperformed just don't know it and actually believe they are doing well. Consider that a simple 65% stocks/35% bonds portfolio more than quadrupled over the past 20 years. For someone whose manager has tripled their assets over this period, he/she will likely feel they have done well. In other words, they are clueless how much their manager has taken in fees and/or underperformed! Probably they will go around touting their manager as a superior investment manager!
Keep in mind that there are always people who break the rules and win big. In one of my favorite books, Rocket Boys, the memoir by Homer Hickam, the mother put every last cent in Johnson & Johnson stock because she saw all the kids in the neighborhood constantly needing bandaids etc. for their recurring scrapes. She undoubtedly would look befuddled at the mention of diversification. But her one stock approach bought her a nice place in Myrtle Beach!
A final point made in this ongoing debate is on the failure of superior performance to persist. This means that picking the 200 to 300 market beaters over the last 10 years is futile. What is generally missed, however, is that some percentage of the underperformers from the first 10 years will outperform by such an extent over the next 10 years that they will be superior performers over the 20 years! Like zombies they come back!
Other than the irksome (to me) percentage, Tony Robbin's book is interesting albeit way too long and too much of a pump-it-up infomercial for my tastes.
Monday, March 21, 2016
How Active Managers Sucker Naive Investors In
Here is another article at MarketWatch that naive investors should throw in the trash:
Why buy-and-hold is a bad idea for retirees by Ken Moraif.
Two points first: MarketWatch is one of my favorite sites because most articles are informative, timely, and well-written. Secondly, this straw-man type of bashing of "buy and hold" is quite popular and used to charge egregious fees in my opinion.
Why should the article be trashed? I suggest you read the article first and see if you can figure it out. If you can't, then you need help in the investment world because you are set up for the manager who wants 1% to 2% of your assets annually and is likely to underperform. You need to do some research or get some guidance on the hit your nest egg takes over a longer period of time as you contribute to the average underperforming active manager's coffers (see: article on recent SPIVA scorecard.)
Now to the article. The author presents an example which shows the retiree who put all of his or her money in stocks in 2000:
So in 2000, your first year of retirement, you took out $40,000, but, oops, the market went down 10%, and you lost $100,000. You were left with $860,000. Then the market dropped 13% in 2001, gobbling almost $112,000 of your investments, plus you took out $41,200* to live on. Your investments fell to $700,000.
After 3 years he claims:
You lost half your nest egg in three years.
Now let's take a deep breath and step back a minute and ask the very basic question of who would put their nest egg 100% in stocks. Maybe the author's firm recommends retirees put 100% in stocks, but I know of no others that do.
To be clear on the difference, let's take a look at his returns versus more reasonable numbers. He says the market was down -10%, -13% and -23% in 2000, 2001, and 2002. What was the performance of a buy-and-hold investor for these years using a 65% stocks/35% bonds basic, reasonable buy-and-hold allocation? Using the BlackRock Asset Class Returns chart, you can see they were -1.1%, -4.8%, and -9.8% for 2000, 2001, and 2002 respectively. A huge difference!
The discerning reader may have also noticed that the author assumes 3% inflation for the withdrawal schedule. He could have an interesting conversation with Fed Chairperson Janet Yellen who has been trying to reach the Fed's goal of 2%.
The bottom line is that the author has used wholly unrealistic assumptions to reach his conclusions--which could negatively impact the undiscerning reader.
What if I was to flip this around and seek to create a straw-man type of argument in the other direction and ask how active investors fared who put their entire nest egg in Pershing Square (the firm managed by former active hedge fund manager Bill Ackman). That story by Brett Arends is here: Bill Ackman's stock drops.
Why buy-and-hold is a bad idea for retirees by Ken Moraif.
Two points first: MarketWatch is one of my favorite sites because most articles are informative, timely, and well-written. Secondly, this straw-man type of bashing of "buy and hold" is quite popular and used to charge egregious fees in my opinion.
Why should the article be trashed? I suggest you read the article first and see if you can figure it out. If you can't, then you need help in the investment world because you are set up for the manager who wants 1% to 2% of your assets annually and is likely to underperform. You need to do some research or get some guidance on the hit your nest egg takes over a longer period of time as you contribute to the average underperforming active manager's coffers (see: article on recent SPIVA scorecard.)
Now to the article. The author presents an example which shows the retiree who put all of his or her money in stocks in 2000:
So in 2000, your first year of retirement, you took out $40,000, but, oops, the market went down 10%, and you lost $100,000. You were left with $860,000. Then the market dropped 13% in 2001, gobbling almost $112,000 of your investments, plus you took out $41,200* to live on. Your investments fell to $700,000.
After 3 years he claims:
You lost half your nest egg in three years.
Now let's take a deep breath and step back a minute and ask the very basic question of who would put their nest egg 100% in stocks. Maybe the author's firm recommends retirees put 100% in stocks, but I know of no others that do.
To be clear on the difference, let's take a look at his returns versus more reasonable numbers. He says the market was down -10%, -13% and -23% in 2000, 2001, and 2002. What was the performance of a buy-and-hold investor for these years using a 65% stocks/35% bonds basic, reasonable buy-and-hold allocation? Using the BlackRock Asset Class Returns chart, you can see they were -1.1%, -4.8%, and -9.8% for 2000, 2001, and 2002 respectively. A huge difference!
The discerning reader may have also noticed that the author assumes 3% inflation for the withdrawal schedule. He could have an interesting conversation with Fed Chairperson Janet Yellen who has been trying to reach the Fed's goal of 2%.
The bottom line is that the author has used wholly unrealistic assumptions to reach his conclusions--which could negatively impact the undiscerning reader.
What if I was to flip this around and seek to create a straw-man type of argument in the other direction and ask how active investors fared who put their entire nest egg in Pershing Square (the firm managed by former active hedge fund manager Bill Ackman). That story by Brett Arends is here: Bill Ackman's stock drops.
Friday, February 5, 2016
My Favorite Investment Chart
The
BlackRock Asset Class Returns - A 20-Year Snapshot
chart has just been released for the period through 2015. This is a 2 page chart many advisors would not want you to see. It illustrates that investing in low cost Funds over an extended period, using a buy and hold strategy has produced excellent returns with relatively low volatility.
Understanding what this chart shows can make a huge difference for those trying to build a nest egg for retirement. Understanding this chart reveals how many investors could have invested their 401(k)s as well as their other monies to achieve better performance. It is useful for comparing their performance as well as their advisor's performance.
The first page shows year by year the returns of 7 different asset classes with each color coded so that it is easy to see for any given year the top performing sectors as well as the lower performing sectors. They also show a diversified portfolio as the white box. The diversified portfolio is comprised of all the sectors. The actual composition of the diversified portfolio is provided in the last footnote on the first page of the charts.
The first thing that jumps out is that the diversified portfolio is never among the top 2 performers but also is never in the bottom 2. This is a visual depiction of the fact that diversifying reduces volatility.
A second point is that chasing the hottest sectors can be hazardous to your investment health. Notice that in 1998 and 1999 the top performing sector was Large Cap Growth. For the ensuing 3 years this sector was at or near the bottom.
A third point to note is that the Fixed Income sector (i.e. bonds) produced a negative return in only 2 out of the 20 years. This is worth some consideration because investors tend to be leery of bond Funds because bond prices go up and down and managers therefore may sell at losses and buy at higher prices. The overall market though, as shown, is much better behaved in terms of loss aversion. The index shown is for the entire U.S. investment grade bond market and holds bonds until they reach 1 year left to maturity.
The second page of the chart shows line graphs of the sectors as well as the cumulative and average annualized returns and standard deviations. Keep in mind, as you look at this chart, all the events that occurred that kept nervous investors out of the market including terrorist attacks, the "Great Recession", Greece threatening the viability of the European Union with its debt issues, and even shutting down the government. Despite these the patient investing of $100,000 at the beginning of the period ended up at $417,329! The average annualized return was 7.4% and the standard deviation as shown in the table was a relatively low 10%.
It goes without saying that many financial advisors who charge big fees would love to have results close to these to report to their clients.
It is a sad commentary however that many investors have no idea what they could achieve. Over the period shown many investors would feel their advisor (or they themselves for that matter) had done a good job if they had turned $100,000 into $315,000 say.
Some may question at this point what happened to the extra $100,000. For an answer read "Where Are the Customers' Yachts ?" by Fred Schwed.
Disclosure: this post is for educational purposes. Investors should do their own research or consult with professionals before making investment decisions.
BlackRock Asset Class Returns - A 20-Year Snapshot
chart has just been released for the period through 2015. This is a 2 page chart many advisors would not want you to see. It illustrates that investing in low cost Funds over an extended period, using a buy and hold strategy has produced excellent returns with relatively low volatility.
Understanding what this chart shows can make a huge difference for those trying to build a nest egg for retirement. Understanding this chart reveals how many investors could have invested their 401(k)s as well as their other monies to achieve better performance. It is useful for comparing their performance as well as their advisor's performance.
The first page shows year by year the returns of 7 different asset classes with each color coded so that it is easy to see for any given year the top performing sectors as well as the lower performing sectors. They also show a diversified portfolio as the white box. The diversified portfolio is comprised of all the sectors. The actual composition of the diversified portfolio is provided in the last footnote on the first page of the charts.
The first thing that jumps out is that the diversified portfolio is never among the top 2 performers but also is never in the bottom 2. This is a visual depiction of the fact that diversifying reduces volatility.
A second point is that chasing the hottest sectors can be hazardous to your investment health. Notice that in 1998 and 1999 the top performing sector was Large Cap Growth. For the ensuing 3 years this sector was at or near the bottom.
A third point to note is that the Fixed Income sector (i.e. bonds) produced a negative return in only 2 out of the 20 years. This is worth some consideration because investors tend to be leery of bond Funds because bond prices go up and down and managers therefore may sell at losses and buy at higher prices. The overall market though, as shown, is much better behaved in terms of loss aversion. The index shown is for the entire U.S. investment grade bond market and holds bonds until they reach 1 year left to maturity.
The second page of the chart shows line graphs of the sectors as well as the cumulative and average annualized returns and standard deviations. Keep in mind, as you look at this chart, all the events that occurred that kept nervous investors out of the market including terrorist attacks, the "Great Recession", Greece threatening the viability of the European Union with its debt issues, and even shutting down the government. Despite these the patient investing of $100,000 at the beginning of the period ended up at $417,329! The average annualized return was 7.4% and the standard deviation as shown in the table was a relatively low 10%.
It goes without saying that many financial advisors who charge big fees would love to have results close to these to report to their clients.
It is a sad commentary however that many investors have no idea what they could achieve. Over the period shown many investors would feel their advisor (or they themselves for that matter) had done a good job if they had turned $100,000 into $315,000 say.
Some may question at this point what happened to the extra $100,000. For an answer read "Where Are the Customers' Yachts ?" by Fred Schwed.
Disclosure: this post is for educational purposes. Investors should do their own research or consult with professionals before making investment decisions.
Monday, January 11, 2016
Target Date Funds Comparison
Here is a nice article on Target-Date Funds by John Presto at MarketWatch: Opinion: Target-date retirement funds may miss the mark for investors.
This is the type of article that is mostly not read by investors who need to read it because, by definition, most target date Fund investors are in these types of Funds because they don't want to make their own decisions on which Funds to buy and how to allocate their overall assets.
The article emphasizes the important points to consider. First, you want to ascertain that index funds, as opposed to actively managed funds, are used. Secondly, you want to understand the asset allocation, i..e., the percentage in stocks and bonds. Is 87.1% or 89.5% the right percentage to be invested in stocks? Only Dr. Who knows; and he is in a cave at an undetermined location--so forget trying to figure that out. And thirdly, you want an idea of the "glide path," that is, how the Fund becomes more conservative over time.
,
You do however, want the Fund to have a decent "glide path." Moving through the years from being 30 years from retirement to retirement should result in a substantive increase in bonds and a consequent reduction in equities. The table in the article showing only a slight equity exposure reduction for the Fidelity Fund was puzzling.
Another consideration is the risk tolerance of young people. In an ideal world, young people should be aggressively invested, contribute on a regular basis at least 12% of gross income, and ignore the market value of their Funds as well as financial news. Financial news, like news in general, is biased to be negative and will cause some younger people to stress out over the ups and downs of their portfolio as well as the potential for such based on pundits' assessments of financial events. Young investors can easily dampen the volatility by utilizing a money fund in conjunction with the target-date Fund or choosing a Fund 10 years prior to their retirement date.
The bottom line on target-date funds is that they are better than investing in money funds, as the article points out. Also, they have in this regard been a positive, in that they are the right vehicle to opt employees into the company 401(k). There also can be some exploitation of investors by adding Funds that a Fund provider is trying to build up in terms of assets under management, and they are a bit more expensive compared to constructing the same basic allocation with the lowest cost index Funds.
This is the type of article that is mostly not read by investors who need to read it because, by definition, most target date Fund investors are in these types of Funds because they don't want to make their own decisions on which Funds to buy and how to allocate their overall assets.
The article emphasizes the important points to consider. First, you want to ascertain that index funds, as opposed to actively managed funds, are used. Secondly, you want to understand the asset allocation, i..e., the percentage in stocks and bonds. Is 87.1% or 89.5% the right percentage to be invested in stocks? Only Dr. Who knows; and he is in a cave at an undetermined location--so forget trying to figure that out. And thirdly, you want an idea of the "glide path," that is, how the Fund becomes more conservative over time.
,
You do however, want the Fund to have a decent "glide path." Moving through the years from being 30 years from retirement to retirement should result in a substantive increase in bonds and a consequent reduction in equities. The table in the article showing only a slight equity exposure reduction for the Fidelity Fund was puzzling.
Another consideration is the risk tolerance of young people. In an ideal world, young people should be aggressively invested, contribute on a regular basis at least 12% of gross income, and ignore the market value of their Funds as well as financial news. Financial news, like news in general, is biased to be negative and will cause some younger people to stress out over the ups and downs of their portfolio as well as the potential for such based on pundits' assessments of financial events. Young investors can easily dampen the volatility by utilizing a money fund in conjunction with the target-date Fund or choosing a Fund 10 years prior to their retirement date.
The bottom line on target-date funds is that they are better than investing in money funds, as the article points out. Also, they have in this regard been a positive, in that they are the right vehicle to opt employees into the company 401(k). There also can be some exploitation of investors by adding Funds that a Fund provider is trying to build up in terms of assets under management, and they are a bit more expensive compared to constructing the same basic allocation with the lowest cost index Funds.
Sunday, January 3, 2016
Estimated 2015 Performance of BlackRock Diversified Portfolio
Regular readers know my favorite investment chart is the BlackRock 20-year sector performance.
It details the relative performance ranking of asset classes on an
annual basis as well as the
performance of an easily replicated low-cost diversified portfolio
comprised basically of 65% stocks, 35% bonds. As can be seen by
referencing the above link, the diversified portfolio returned 8.7% on
an average annualized basis over
the 20-years ended 12/31/2014.
The diversified portfolio allocation is an appropriate benchmark for many individuals in their 40s and even early 50s, depending on their specific risk tolerance. The chart contains sufficient data, however, to construct a benchmark and analyze performance for any specific allocation; and, in fact, the allocation can be changed over time using the data in the table--as it should be as an individual ages.
Voluminous data from unbiased academic studies have been presented over the years showing that a diversified portfolio of low-cost funds outperforms upwards of 70% of active managers over the longer term, after all costs are taken into account. These studies cover various time periods, countries, asset classes, and investment methodologies. In line with this data, the low-cost diversified approach warrants consideration as a benchmark for investors. It shouldn't go unnoticed that the approach economizes on the investor's time.
Below is an update showing the estimated performance of the diversified portfolio's sectors for the 12 months ended 12/31/2015. Overall, the portfolio returned approximately -.03%. This was a year pundits labeled "violently flat." Although there were big up and down moves, well-diversified portfolios tended to be unchanged.
For the 12-month period, sector performance was mixed with small growth stocks doing best, followed by the investment grade bond market which eked out a small gain. Small cap value stocks did especially poorly. Commodities, including oil, had an especially horrendous year and were responsible for weighing down the broad averages.
Disclosure: This post is intended for educational purposes only. Past performance is not indicative of future performance. Individuals should consult a professional or do their own research before making investment decisions.
The diversified portfolio allocation is an appropriate benchmark for many individuals in their 40s and even early 50s, depending on their specific risk tolerance. The chart contains sufficient data, however, to construct a benchmark and analyze performance for any specific allocation; and, in fact, the allocation can be changed over time using the data in the table--as it should be as an individual ages.
Voluminous data from unbiased academic studies have been presented over the years showing that a diversified portfolio of low-cost funds outperforms upwards of 70% of active managers over the longer term, after all costs are taken into account. These studies cover various time periods, countries, asset classes, and investment methodologies. In line with this data, the low-cost diversified approach warrants consideration as a benchmark for investors. It shouldn't go unnoticed that the approach economizes on the investor's time.
Below is an update showing the estimated performance of the diversified portfolio's sectors for the 12 months ended 12/31/2015. Overall, the portfolio returned approximately -.03%. This was a year pundits labeled "violently flat." Although there were big up and down moves, well-diversified portfolios tended to be unchanged.
For the 12-month period, sector performance was mixed with small growth stocks doing best, followed by the investment grade bond market which eked out a small gain. Small cap value stocks did especially poorly. Commodities, including oil, had an especially horrendous year and were responsible for weighing down the broad averages.
Weight (%)
|
Fund
|
Return (%) 12 months ended 12/31/2015
|
35
|
AGG (Barclay’s Aggregate Bond Index)
|
+0.48
|
10
|
EFA
(EAFE Index)
|
-1.00 |
10
|
IWM (Russell 2000)
|
-4.47
|
22.5
|
IWF
(Russell 1000 Growth)
|
+5.50
|
22.5
|
IWD (Russell 1000 Value)
|
-3.97
|
Disclosure: This post is intended for educational purposes only. Past performance is not indicative of future performance. Individuals should consult a professional or do their own research before making investment decisions.
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