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.
Showing posts with label retirement date funds. Show all posts
Showing posts with label retirement date funds. Show all posts
Monday, September 5, 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.
Subscribe to:
Posts (Atom)