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.
Monday, August 29, 2016
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.
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