Getting Income from Your Retirement Portfolio


This is part of a series of posts for an online class on how to use your investments to fund your retirement.  To find other posts in the series, select the category  “Retirement Investment Class” under “Retirement Investing” at the top.  The posts will appear in reverse order, with the newest post first. 

A portion of your retirement portfolio should be dedicated to generating current income.  This means that you want assets in your portfolio to be sending you a check regularly so that you can pay for food, utilities, and other expenses you’ll have in retirement.  For example, if you own bonds they will send you an interest check twice per year.  Likewise, many stocks will send you a dividend check four times per year.  REITs (Real estate portfolios) will send you money from rents that they receive from properties in the portfolio.  All three of these types of investments will also send you capital gains distributions periodically from when they sell a security at a profit.  While you can also sell off shares to generate cash, it is better to have interest and dividend payments coming into your account so that you don’t generate brokerage commissions and other costs by selling.  Once you have things set up, it also means that you don’t need to do much of anything.

To show how the process works, let’s assume that I have a two million dollar portfolio, of which I’m using $1.5 M to generate income.  The other half-million I am leaving in growth stocks to keep up with inflation and get better returns than I can from income generating assets.  I’ll use a combination of bonds, dividend-paying stocks, and REITs to generate income.  Let’s say that I want to generate about $50,000 per year in current income from the portfolio.

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Looking through the Vanguard funds, I find the following:

Bond Funds:

Long-Term Bond Index – Yield 3.78%

Total Bond Market Index – Yield 2.96%

Long-Term Corporate Bond Index – Yield 4.42%

High-Yield Stock Funds:

High-Dividend Yield Corporate – Yield 2.89%

REIT Funds:

Real-Estate Index Fund – Yield 4.03 %

I’ll use these funds as building blocks to generate the income I want.  Bond funds tend to pay the most cash, but the higher-paying bonds funds are also riskier.  The amount they pay (in dollars) will also stay relatively fixed with time, while the value of a dollar will decrease due to inflation, so over many years my spending power will be reduced if I only buy bond funds.

The dividend-paying stocks don’t pay as much as the bond funds, but the amount that they pay will increase with time.  I may only get $5,000 from a dividend fund this year, but in ten years I may be getting $10,000.  An equal investment in a bond fund may pay $7500 this year, but in ten years it will still be paying $7500.  The dividend part of the portfolio will help me keep up with inflation.  The growth stock portion will do this as well.

The REIT fund will pay as well as some of the bond funds, but also will have some capital appreciation, helping to keep up with inflation as well.  It is also in a different sector of the economy than stocks or bonds, so the price of the fund may stay up when the stock and bond funds go down and vice-versa.  This adds stability to the value of my portfolio.

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The strategy is to utilize the higher-yielding bond funds to increase my returns, but also buy some lower-yield funds for security and to reduce volatility.  I’ll add dividend-producing stocks for growth of income.  I’ll add REITs to help provide income, stability, and some capital appreciation.

Let’s say that I invested as follows:

Long-Term Bond Index – $200,000, yearly income $7560

Total Bond Market Index – $200,000, yearly income $5920

Long-Term Corporate Bond Index – $300,000, yearly income $13,260

High-Dividend Yield Corporate – $300,000, yearly income $8670

Real-Estate Index Fund – $500,000, yearly income $20,150

My total income would be $55,560, which is $5560 above my goal.  This is fairly close to my goal, so I may say this is good enough and go with it.  The portfolio is nicely balanced, with 47% in bonds, 20% in bonds, and 33% in real-estate.  If I really didn’t need more than $50,000, I would probably shift more money into the high-yield stock fund, which would reduce my current income but increase my future income and get a little better overall return on the portfolio over time.

So there you have it – the strategy for setting up the income portion of your portfolio.  Develop a list of funds with their yields, allocate money to each fund, trying to spread the money out among bonds, dividend-paying stocks, and real estate, and then adjust the allocations until you reach your needed income needs.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Sneak Preview of Cash Flow Your Way to Wealth


 

I’m working on the last read through of Cash Flow Your Way to Wealth and expect the book to be released within a month.  I’m very excited!  I think it will help a lot of people learn to manage their money well and become financially independent.  Here’s a sneak preview of the book.   This is the Introduction, which sets the stage for the rest of the book.

Most people have the opportunity to become wealthy within their lifetimes, just using the income they have from their jobs. The reason that few do is because of the way they handle their money once they earn it, also known as how they setup their cash flow. Their whole lives they setup and maintain the cash flow of a middle class person, or even the cash flow of a poor person. People who will become rich and stay that way have setup the cash flow of a rich person. Even if you were to take all of the wealth accumulated by the wealthy people away, they would be wealthy again in a few years because of the way they have configured their cash flow. Likewise, if you gave the poor or the middle class people a bunch of money, in a few years they would be back where they were again because of the way they setup their cash flow. Knowing how to setup the cash flow of a rich person is the key to becoming wealthy, regardless of your income level.

The term “cash flow” is often used to describe the amount of money passing through your fingers each month, and many people say that the reason they cannot improve their financial place in life is because their cash flow is too small. But your cash flow is also how money flows into, through, and out of your life. This is the definition we’ll use in this book. Everyone has some sort of cash flow, regardless of their income. Even if you don’t deliberately configure and control your cash flow using a cash flow plan, you still have one.

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Most people have a cash flow that is exactly balanced – every dollar that comes in goes out. In fact, many people don’t even see their money at all since their checks are direct deposited and their bills are paid automatically. They just know that their lights don’t typically get shut off, so things must be working. The issue with this sort of cash flow, however, is that it is extremely fragile. Any disruption in your income stream will result in the light bills not being paid and your lights being shut off.

The purpose of this book is to help the reader develop a different sort of cash flow. One that causes wealth to be built over time. Very quickly (in less than a year) an individual with this sort of cash flow will be protected from minor disturbances such as a missed paycheck or an unexpected expense like a car repair. Within a few years the same individual will be protected from major disturbances like a job loss with a couple of months spent finding another one. After a couple of decades, financial independence can be built – that magical state where one no longer depends on a job to pay for basic bills and put food on the table. In other words, financial security.

To understand the different kinds of cash flow, picture a large canyon. A water source flows into this canyon from one end. For some people it is a small creek. For others it is a moderate stream. For others it is a raging river.

Many people would see the raging river and think that the individual who owned that canyon would never run out of water. Truth be told, most people we think of as rich do not necessary have a rich-person cash flow, but instead are individuals with a raging water income. These are people who are NBA stars with multi-million dollar deals, rock stars, brain surgeons, and Wall Street financiers. They probably drive Lamborghinis and Ferraris, live in huge homes with maybe a servant or two, and are always going on lavish vacations and out to the finest restaurants.

Those in the middle class would have a moderate stream income. Many of them would drive late model cars, but be limited to SUVs and maybe a lessor luxury-brand like a Lexus. They would still eat out a lot but usually at the moderately priced chains with perhaps a spurge on a nicer restaurant once in a while. They would have nice homes with large yards and granite counter-tops, but nothing like the mansions owned by the raging water set. While they would not have as much water flowing through their canyons, you would still not expect them to run out of water very easily and expect the stream to always be flowing.

Those in the working class would have a creek flowing into their canyon. It would be steady, but nothing excessive. They would drive older cars, live in modest homes or apartments, and generally need to watch their money carefully to cover everything. At times the creek may slow and even dry up for a period of days. If you were living with a creek income, not being able to afford the things you need would be a concern.

 

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The truth is, however, that all of these individuals are equally vulnerable. All of the water flowing into the canyon flows right back out. Even for the individuals with the raging river income like a movie star, if there is a disruption in the flow of water coming into the canyon – like if someone builds a dam upstream (a job loss or an injury), they could very quickly be in trouble.

Now picture the same canyon with the same water source flowing into it, but now place an earthen dam at the downstream end. Now the water does not all flow out instantly – water starts to rise in the canyon, forming a small pond, then a small lake. Obviously the water level would rise a lot faster for the individuals with a raging river flowing into their canyons, but even those with just a creek would see water building up over time.

Now, these individuals are protected somewhat from an interruption in their income stream. When the water stops flowing for a period of time, depending on how far their canyon had filled with water before the interruption, they would have some buffer before they ran out of water. The amount of time they had would depend on how many holes they had in their dam – how many expenses they had each month.

Individuals who become wealthy – truly wealthy – build dams at the end of their canyons. They also limit the number of holes in their dams and work to increase the water source coming into their canyons. In fact they build additional feeder streams into their canyons, called assets, that build upon themselves to increase the flow over time This causes their canyons to fill with water and become large lakes from which they can draw and never worry about running out of water because of the feeder streams replenishing any water that they remove.

In this book you’ll learn how to manage your cash flow to build a dam at the end of your canyon. You’ll learn how to increase your income by adding feeder streams, assets, that will increase how much water is flowing into your canyon. You’ll learn the investments that you must make to pay for important things like retirement. And then you’ll learn how to set yourself up to never need to worry about money again. It all starts and ends with a cash flow plan.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The First Small Investor Investing Twitter Show


 

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Join me for the first Small Investor Investing Twitter show.  I’ll be answering questions on investing and personal finance by Twitter live  from 8-9 PM Eastern Standard Time Sunday night (3/4/2018).  Also look for a post on the basics of stock investing here at the site, and feel free to send in your questions as comments or via twitter @Smallivy_SI.

See you Sunday night!

 

SI

Is an Annuity Right for Part of Your Retirement Funding?


This is part of a series of posts for an online class on how to use your investments to fund your retirement.  To find other posts in the series, select the category  “Retirement Investment Class” under “Retirement Investing” at the top.  The posts will appear in reverse order, with the newest post first. 

I have recently gained a new appreciation for annuities, or at least the promise that an annuity holds.  At one point I swore off annuities entirely and there are good reasons to do so.  These include:

  1. You can do better investing the money yourself.
  2. The fees can be high.
  3. You generally have little flexibility once you have made the purchase, and may need to pay a big fee to receive any of the money back.

But then I realized the true purpose of an annuity is the same as it is for any insurance product:

To shift your risk to the insurance company in exchange for the cost paid.

All annuities pay you a specified amount of money for a specified period of time in exchange for you handing over a load of money to the insurance company.  For example, you give them $100,000 and they agree to pay you $500 per month for the rest of your life.  In many ways this is like a pension plan where you receive payments, except this is from an insurance company instead of an employer.  In fact, many employers that still have pension plans use annuities to make the payments once individuals retire so that they don’t need to worry about it.  They just buy an annuity that pays the former employee whatever is needed when they retire and then the employer’s part is done.  You can create your own pension using an annuity if you commit your 401k funds or other retirement savings.

Now while there are probably as many different kinds of annuities as there are stars in the sky, since they are all just insurance polices and the types are only limited by the imagination of the companies that create them, there are really only two types of annuities that should hold any interest for you.  These are immediate annuities and deferred annuities.  And here we just want the plain vanilla types – no bells and whistles.

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Immediate annuities are just that – you give them money and they immediately start making payments to you.  These are used to provide regular income without needing to worry about what the markets are doing, buying and selling mutual funds, or performing other actions.  Deferred annuities pay after you reach some certain date, for example, starting to pay you $5,000 per month after you reach age 85.  These are used as insurance against outliving your money.

So why are annuities not as good as investing yourself, in general?  The reason is both that they charge fees (which can be big) and the return you get from an annuity, including fees, will not be as great as you would get if you had invested yourself.  For example, if you were to invest $1 M at age 65 in a balanced stock and bond portfolio, you would be able to receive about $40,000 per year, indexed for inflation, until you were age 95.  At that point you would have on average about $2 M in the account and have received about $1.8 M in payments during that time.  The $2 M would be able to buy about what $1 M can buy today, so you would effectively have all of the money you started with, plus have received an income to fund a $40,000 (in year 2018 dollars) per year lifestyle.

If instead you were to put the money into an immediate annuity, you might start getting paid about $75,000 per year, fixed.  If you then died at age 95, you would have received about $2.25 M during that period.  This sounds better than the $1.8 M you received from the investment portfolio, but the insurance company would keep the money you gave them when you died, leaving nothing for you to pass on to your heirs or from which to pay for your final expenses.  You would have gotten $450,000 less in income from investing, but would have $2 M in savings remaining instead of nothing.  Because an account can withstand about a 4% withdrawal rate without declining in value over time, spending at this rate can be done essentially forever, assuming no black swan market event occurs.

In addition, while you would start out better with the annuity, receiving $75,000 per year instead of $40,000 per year from the investment account, by the time you were 95 you would be receiving about $80,000 per year from the investment account where you would only be receiving $75,000 per year from the annuity.  While your spending power would start out greater with the annuity, the payments from the investing account would pass it up along the way and you’d be having a little more trouble meeting expenses with the annuity near the end.

Hey – if you like The Small Investor, help keep it going.  Buy a copy of SmallIvy Book of Investing: Book1: Investing to Grow Wealthy, buy one of the products shown, or just click on one of the product links and then browse and buy something else you need from Amazon’s huge collection.  The Small Investor will make a small commission each time you buy a product through one of our links.

So why would you want to have an annuity instead of just investing yourself?  The beauty of the annuity is that you would (nearly) eliminate the risk of a market drop affecting your income.  Annuities also help protect you in the case that you live longer than average since many of them pay income until you die.  In fact, you’ll be able to utilize more of your money while you are alive using an annuity than you would investing yourself because, while you would need to limit your withdrawals to make sure you didn’t run out of money before you die if you’re investing yourself, the insurance company knows that if they sell 10,000 annuities, the average age at which people will die and distribution of ages is predictable and they can determine with a fair amount of certainty how much they’ll need to pay out.  They are therefore able to provide a higher payout per month than they could if they were just insuring a single person who might live to be 115.  If they know from historic data that the average person would live to age 84, for example, and how many people will live longer, they can determine the maximum payout they can make and not lose money.

Note that if you die young, say at age 66 when you buy the annuity at age 65, the insurance company would probably keep your whole $1 M.  This makes up for the people who live to be 100 and withdrawal more than the insurance company can make from their investment.  This is the nature if insurance – some people pay for more than they use to make up for those who pay for less than they use.     

And therein lies the reason that some people would want to use an annuity and others should invest for themselves.  If you are interested in leaving a lot of money to your kids or a favorite cause and you have enough money saved to allow you to generate enough income for expenses using 3-4% of the value of your savings each year, invest yourself.  If you don’t want to leave money, yet you don’t want to risk running out of money either, use an annuity.  You could also do a little of both, using an annuity for a portion of your savings to gain the additional income, but keep some invested in stocks to provide growth to allow you to increase your income should you live a long time and inflation starts really affecting the buying power of your annuity payments.

As far as what an annuity can and should pay you. realize that the insurance company will invest the money, probably mostly in common stocks if they don’t use the money to underwrite other insurance policies,.  The most they could pay would therefore be equal to the withdrawal rate they could make for the average life expectancy and have the money last.  As an example, if a person who is 65 buys and $1 M annuity and the insurance company figures out that the average person in the buyers risk-pool is likely to live 30 years, they could pay about $5368 per month or $64,418 per year if they were able to make an annualized rate-of-return of 5%, or about $7337 per month or $88,050 per year if they were able to make an annualized rate-of-return of 8%.

The amount they would offer would be somewhat less than this since they would take a fee off-the-top to pay the person selling you the policy, plus the insurance company would want to make a profit from the policy to make it worth their time, plus they may want to pay a bit lower than they would expect to make in case the markets don’t perform well during the period and don’t return as much as they were expecting.  They might therefore offer you $4500 per month if they were expecting to make 5% instead of the $5368 per month that they were expecting to make investing the money.  If there is ample competition (and you should shop around to make sure you get the maximum pay-out you can while still using a solid provider), you should get a reasonable return and their profit should be reasonable for the risk they are taking and their costs.

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Annuities are also a great choice if you have not saved as much as you really should have.  For example, if you have only saved up $250,000 by retirement, plus you have a home worth $500,000, you could maybe downsize or move to a lower-cost area and pull $350,000 out of your home.  (You could also possibly use a reverse-mortgage if you wanted to stay in your home, but again you would be paying a lot of fees in doing so.)  You could then take the $600,000 you had available and maybe buy an annuity paying $3,000 per month, or $36,000 per year.  Combined with Social Security, you should be able to make it through, although it might get tight if you live a long time after retirement.  You should therefore work as long as you can and build up all that you are able before you retire.  This will both increase your possible pay-out and reduce the number of years you’ll be in retirement.

But what if you want to have a good chance of spending most of your money, but want to get a better return that you will from an annuity?  If you have saved enough to fund your monthly expenses from investment returns, there is a way that you can invest yourself and still use more of your money than you will if you limit yourself to a 3-4% withdrawal, yet still have a low chance you will outlive your money.  The secret is to start out conservative, but then increase your withdrawal rate as you go.

For example, if you had $1 M and retired when you were 65, you would start out at 4%, or $40,000 per year.  At this rate there is a good chance your portfolio value will not drop at all (in inflation-adjusted terms).  If you wanted to be even more conservative, you could limit yourself to 3%.  After five years, at age 70, you could start spending at a rate that would exhaust your savings in 30 years, assuming some reasonable rate-of-return.  For example, as shown before, a 5% rate-of-return would result in a yearly payment of $64,418 as shown before.  Because your chances of living to 100 are fairly low (depending on the ages of your parents when they died, your current health, and other factors), you are fairly safe increasing your spending and starting to spend down your savings at this rate.

If you are still worried, you could also take some of the money and buy a deferred annuity that kicks in at age 90 or something.  Since it is unlikely that the insurance  company would expect you to receive many (or any) payments from this policy, the amount you would need to contribute to receive enough income for expenses at age 90 and beyond would be fairly low.  Plus, your expenses at age 90 if you live that long will likely be fairly modest.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Beauty of the US – Everyone Has an Equal Chance


I was thinking the other day about what it would be like to go out on your own, a few hundred dollars in your pocket, and try to make it in the world.  Thinking about trying to find a place to live, find a job, buy clothes, food, and other necessities.  One thought was that it would be difficult for someone who came from an impoverished background, with both parents on welfare because of medical conditions or lifestyle choices, to get a decent job because such an individual would not be able to get the education needed to move into better paying jobs.  It seemed like they would be at a great disadvantage to someone from an upper-class or middle-class background.

But then it occurred to me – those in the US whose parents are poor have an equal ability to pay for college, even at elite school, as those who come from wealthier backgrounds.  If anything, they are in better shape than the typical middle-class family.  How so?

Hey – if you like The Small Investor, help keep it going.  Buy a copy of SmallIvy Book of Investing: Book1: Investing to Grow Wealthy, buy one of the products shown, or just click on one of the product links and then browse and buy something else you need from Amazon’s huge collection.  The Small Investor will make a small commission each time you buy a product through one of our links.

There is an enormous amount of educational welfare available, coming from both the Federal Government and the schools themselves, that really make the ability to pay for school equal for all, or even to the advantage of those from poor backgrounds.  A student whose parents make $150,000 per year will probably pay something like $25,000 per year to go to Duke University or Harvard.  If that same student’s parents also had a couple of million dollars in the bank, even if they made $80,000 per year instead of $150,000 per year in salary, they would probably pay most of all of the $45,000 per year it costs to attend Duke or Harvard, including room and board.

Someone whose parents make nothing and have nothing saved up would pay nothing to go to those same schools.  They could go to a community college, a state school, or even an elite private university and pay nothing to do so!  Between the reductions or eliminations in tuition that these schools provide to students who show financial need and the grants given out by the federal government, which do not need to be paid back, students from poor backgrounds see little if any cost for going to college.  So there is really no financial reason for a student not being able to leave home and gain the education needed to make very good money in the US even if his/her parents didn’t make more than $10,000 per year their whole lives.

So the first lesson for those reading this article from poor backgrounds:

There is no financial reason that you cannot learn the skills to increase your income.

Now it is totally different for someone whose parents do make decent money, but are not willing to support their children financially for college.  In this case, the schools and the federal government will look at your parent’s wealth and income and expect them to support a portion of your educational costs based on what they could fund if they wanted to, even if they choose not to do so.  This is really unfortunate since there are parents out there who do cut their children off when they leave home even if the schools and the government expect them to provide support.  It is understandable from the school’s prospective, however, since if colleges just took your word for it, virtually everyone would not give any money to their children for college so that they could go for free.  (Boggles the mind to see that people who would never take charity for other things see nothing wrong with having others fund their children’s education when they could do so themselves, but apparently there’s no taboo when it comes to accepting college financial aid.)  So this is a lesson for parents of middle-class or upper-class background:

Your children will likely get little in terms of financial aid, regardless of whether or not you have saved up money for their college education, so start saving early and plan on footing at least part of the bill to keep them from being buried in student loans.

There are some ways out get out from under this cloud, including waiting until you are 23 or older to go to college, or getting married right out of high school.  Some of the other criteria for not needing to include your parent’s information on financial aid forms are listed here.  There are also a lot of scholarships out there that can help cover college costs that don’t require showing financial need.  These might be an option if you generally have good grades and have been involved in various activities to show you are well-rounded.

Want all the details on using Investing to grow financially Independent?  Try The SmallIvy Book of Investing.  

Now, there are other factors that keep children from impoverished families from going to college and raising their income.  Many don’t have good grades while they are in grade and high school, which is understandable if they have no one at home pushing them at all, or even have a home life that makes it difficult for them to perform well in school.  But again, there are still ways to make a better life for yourself than a series of dead-end, low-pay jobs.

Community colleges:  If you are able make it into a community college, which again could be free for you if you come from a poor family background, you have another chance to change your destiny.  If you concentrate on your studies and get good grades at a community college, many universities would then accept you into their schools.  If you are fortunate enough to get in, spend at least two hours per week doing homework and studying for your classes for every credit hour you are taking.  For example, someone taking 12 hours should be doing 24 hours of work outside of class, for a total of 36 hours per week.  Also, go to office hours for help if you don’t understand something, and spend time getting to know your professors since you will need them for references when you apply to the university.

Trades:  Jobs in the trades pay a lot of money.  If you can do electrical work, plumbing, carpentry, computer repairs, and other similar jobs, you can make a lot more than you will working in retail or at a fast food job.  Many jobs in these areas are earned through experience with a professional in the industry.  If you are willing to be a good worker, showing up on time, being willing to work hard and get the job done, and are willing to learn all that you can while you are on the job, you can get a job with a trade professional and learn what you need to eventually do work on your own.

A final issue for those from poor backgrounds is that their families may continue to drag them down.  Someone whose parents have serious drug or health issues may feel an obligation to take care of siblings still in the home or their parents after they leave the house.  Realize, however, that you can’t save someone from drowning if you yourself are barely keeping your head above water.  It can be better for you and for them if you work to get yourself on firm financial footing first and then help where possible instead of trying to support siblings and parents by working a low-pay job and giving them what you can.  You might also be preventing them from getting welfare because you cause the income of their household to be too high to qualify for food stamps and housing assistance.

While it is difficult, the best option may be to cut financial ties temporally and concentrate on getting through school and raising your income, and then helping them out.  Encouraging your siblings to do what they can, such as getting a job while still in high school and/or working hard at school to get the grades needed to qualify for college is also better than trying to support a family on a minimum wage salary.  Two, three, or four people can do more than a single person can do alone.  Remember that anyone who has health has substantial wealth, even if they have no money in their bank accounts.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Start Out on Your Own


My son, who is a junior in high school, asked me tonight if I could talk to a friend of his who was a senior and who was going to be leaving his house soon and start out on his own.  His friend didn’t know anything about personal finance and wasn’t sure how to get started.  My son wondered if I could give him some advice on money management and how to get set-up in the adult world.

That got me thinking.  Hopefully most children have some sort of help with the transition.  Maybe their parents help them get into their first apartment and then they start to pay their rent from a job.  Maybe they go off to college, which their parents help finance, and then they get a job before leaving school, or come back home for a month or two while they look for a job after college.

But what if you were a couple of months away from graduating high school, and your parents just said that once you graduate, you were on your own?  You just needed to leave home, maybe graduation night, and do whatever you could?  How would you prepare, and what would you do?

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Hopefully you would have a little time.  Let’s say that you had three months to prepare.  Here are the things that I would do:

1.Look at the basics:  Food, shelter, clothing.

To survive, you would need to figure out how you could acquire the basics.  How would you get money for food, shelter, and clothing?  Food for one person would probably be about $200 per month if you planned to eat at home, cook your meals from basic ingredients, and rarely if ever eat out.  Shelter could be somewhere between $200 and $400 per month, depending on where you live, if you did things like rent with a roommate, rent a room in a house, or look for other ways to save money.  You therefore would need to make somewhere in the vicinity of $10,000 – $12,000 per year to pay for the bare necessities for yourself (no children here).

You might be able to get a job that includes shelter (and maybe even food) such as a nanny or live-in housekeeper.  You might also be able to cut your rent by helping your landlord take care of the place by helping with yard care and maintenance.  A little creativity goes a long way when you’re scraping by at the start of life.

2. Think about work.

To gain the money needed for food, shelter, and clothing, you would need to have a job.  To just cover your basic expenses, you really could make it with a full-time minimum wage job at the start.  While you might start out as a fairly basic job, you should use the first job (and the jobs after that until you land your dream job) to learn skills that will help you get a better job.  If you work in a fast food restaurant, use it to learn things like how a business runs, how to please customers, and how to deal with coworkers.  You should also be looking for whatever training your employer can provide since the more skills you have, the more money you can make.

3.  Save up a baby emergency fund.

You probably won’t be able to gather up a full emergency fund of $9,000-$12,000 with your first job, but at least work hard to save up a baby emergency fund of $1,000 or so.  That money will help with some things like a car repair, a short job loss, or a minor illness.  Ideally you should save this money up before you even leave the house.  If you can’t, save as much as you can from your job (and maybe a second job) to get there as soon as you can.

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.4.  Figure out college or a trade school.

Even if you don’t have help from parents, you should look at college or training in a trade.  Luckily, if your parents do not make a lot of money, you will probably be able to go to school for free or nearly free through grants and financial aid.  This might involve a work-study program, but there is nothing wrong with working part-time in the school cafeteria in exchange for thousands of dollars in tuition being waved.  If your parents do make a lot of money, but simply cut you off, it will be a bit more difficult since the schools may still expect you to be able to get help with tuition from your parents.  Using community colleges, that cost a lot less, for the first couple of years and then transferring to a university to complete the degree might be a good way to keep costs down.

Also, if you’d rather work with your hands than sit at a keyboard all day, many trades pay as well or better than jobs for those with college degrees.  Electricians and plumbers can do very well, especially if you eventually start your own business, as do technicians, nurses aides, and other jobs that require an apprenticeship or a couple of years at a trade school.

5.  Move your way up the ladder.

College is one way to possibly increase your pay, but it is not the only way.  You make more money when you become more valuable and are able to serve more people.  If you have a special skill, are able to lead people, or are able to manage large projects, you can make more money.  Always be looking for ways to get additional training and experience through your work and other opportunities that present themselves.  Also always be looking for the next opportunity, either within your business or outside.

Realize that volunteer work can give you opportunities to learn new skills  You might not be able to get to lead a large project at work, but you’ll probably be able to organize charitable events such as food drives and can-ups since few people are wiling to step forward to do so.  You can also meet people you might not otherwise.  Some of the best people volunteer, including community leaders and small business owners who could be your net boss.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Building a Retirement Portfolio with Mutual Funds


This is part of a series of posts for an online class on how to use your investments to fund your retirement.  To find other posts in the series, select the category  “Retirement Investment Class” under “Retirement Investing” at the top. 

Let’s say that you have $2M saved up in your 401k and are ready to retire.  Let’s also say that you need about $50,000 per year to live on the first year, with that amount growing with inflation each year.  Today we’ll discuss how you would use a set of mutual funds to to generate the income that was needed while keeping up with inflation to avoid outliving your money.

The rule-of-thumb is that you can withdraw somewhere between 3% and 4% of your portfolio each year and have a very good chance of having it last through a 30-year retirement.  In fact, the balance could grow under a lot of scenarios.  Withdrawing $50,000 per year from a $2M portfolio would therefore be right in line  with the guidance, since you could withdraw about $60,000 per year and stay at the low end of the range.  You have done well saving and investing throughout your career to put yourself in good shape for retirement.

Ideally you would generate a lot of the income you need for expenses from income producing assets.  You would therefore put a portion of your portfolio in an income or a bond portfolio.  You would also want a portion of the portfolio to grow and keep up with inflation, so you would want to invest the rest in growth and value stock funds.

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We’ll use Vanguard funds as an example.  Looking through their list of funds for income funds, I find the Vanguard Total Bond Market Index fund.  This is a fairly safe fund, although the price could decline if interest rates rise or a serious recession occurs that causes several companies to default on their loans.  In general, as long as I planned to hold this fund regardless of interest rate changes such that price drops due to rising interest rates would not be an issue, chances are good that I would not have any issues.

It is described at the Vanguard website as:  “This fund is designed to provide broad exposure to U.S. investment grade bonds. Reflecting this goal, the fund invests about 30% in corporate bonds and 70% in U.S. government bonds of all maturities (short-, intermediate-, and long-term issues). As with other bond funds, one of the risks of the fund is that increases in interest rates may cause the price of the bonds in the portfolio to decrease—pricing the fund’s NAV lower. Because the fund invests in all segments and maturities of the fixed income market, investors may consider the fund their core bond holding.”

This fund is yielding about 2.5%, so a $1M investment would be paying about $25,000 in interest each year, plus a capital gain from time-to-time.

There is also the High Yield Corporate Bond fund, which is paying about 5.1%, or about $51,000 per $1M invested.  This fund is more risky since the bonds it is investing in are low quality, meaning the companies would be more likely to default than they were with the first fund.  During a recession, I would see some bigger losses in this fund, so I would want to limit my exposure despite the higher yield.  It is described at the Vanguard website as:

“Vanguard High-Yield Corporate Fund invests in a diversified portfolio of medium- and lower-quality corporate bonds, often referred to as “junk bonds.” Created in 1978, this fund seeks to purchase what the advisor considers higher-rated junk bonds. This approach aims to capture consistent income and minimize defaults and principal loss. Although this is a bond fund, high-yield bonds tend to have volatility similar to that of the stock market. This fund may be considered complementary to an already diversified portfolio.”


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I would also look at REITs, which invest in real estate and also generate a reasonable cash return due to the properties in which it invests.  The Vanguard Admiral REIT fund is described as:

“This fund invests in real estate investment trusts—companies that purchase office buildings, hotels, and other real estate property. REITs have often performed differently than stocks and bonds, so this fund may offer some diversification to a portfolio already made up of stocks and bonds. The fund may distribute dividend income higher than other funds, but it is not without risk. One of the fund’s primary risks is its narrow scope, since it invests solely within the real estate industry and may be more volatile than more broadly diversified stock funds.”

It is yielding about 4.3%, or $43,000 per year for a $1 M investment.  REITs would move around a bit since their value depends on the value of the properties it holds, rents they can charge, and other factors.  This portion of the portfolio would also have a growth component since the property values would increase with inflation and as fewer properties were available to buy for a growing population.

You would want your investment mix to be maybe 50% income, 50% growth at 65 years old, so that would leave $1M to invest among these three funds.   I would probably put 50% in the safer bond fund, 25% in the junk bond fund, and 25% in the REIT fund.  This would result in an income of:

Total Bond Fund: $500,000 invested, income $12000/year

High Yield Bond Fund:  $250,000 invested, income  $13,000/year

REIT Fund: $250,000 invested, income $11,000/year

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Your total income would therefore be about $36,000 per year, so you would be about $14,000 per year short of your income goal.  The remainder would need to come from selling stocks off each year, plus a little bit of income from dividends.  For stocks I would look at the Large Cap Index Fund, which is paying out about 1.8% per year, the Small Cap Index Fund, which is paying out about 1.4%, and the Total International Index fund, which is paying out about 2.8%.  With the remaining $1M I would put about 25% in the international fund, and then put 50% in the large cap fund and 25% in the small cap fund.  This would generate income as follows:

Total International Fund:  $250,000 invested, income $7,000 per year

Large Cap Index: $500,000 invested, income $9,000 per year

Small Cap Index:  $250,000 invested, income $3500 per year

So your total income from your stock portfolio would be about $19,500 per year.  Summed together with your bond portfolio, this would equal $54,500 per year in income.  Because you are actually generating more income than you needed, you could either reinvest a portion of the income each year into stocks or bonds.  You could also cut your bond exposure a little and let more of your money grow at the faster, stock market rates.  You could expect a growth rate of about 8% on average from your stocks.

 

Want all the details on using Investing to grow financially Independent?  Try The SmallIvy Book of Investing.  

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Retirement Investing Choices: Annuities


This is part of a series of posts for an online class on how to use your investments to fund your retirement.  To find other posts in the series, select the category  “Retirement Investment Class” under “Retirement Investing” at the top. 

Now that we’ve discussed how much you need to save for retirement and provided some information on mutual funds and ETFs, we can start to discuss some of the different investment options for your retirement portfolio and their role in the big picture of things.  Today we’ll start with an asset called an annuity.

An annuity is an income vehicle issued by an insurance company.  In exchange for turning over some of your money to the insurance company, they agree (guarantee) to pay you a specified amount of money for a specified period of time, which could be the rest of your life.  Because annuities are insurance contracts, there are all sorts of different types, limited only by the insurance company’s creativity in designing a product they hope they’ll buy.

The main benefit of an annuity is the guaranteed income.  That guarantee comes at a price, however, in that the income you receive will be less than the income your money could have generated if you had invested it on your own.  They should therefore be used when security is more important than return, or if you simply don’t want to fool with things and are willing to accept less in exchange for your time and effort.  Annuities are a fix-it-and-forget-it type of investment.

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The most basic type of annuity, called an immediate annuity, simply pays you a specified amount of money starting immediately for a prescribed period of time, often the rest of your life.  For example, let’s say that you buy an immediate annuity at age 70, giving the insurance company $1 M.  They may in exchange give you $4,166 per month, or $50,000 per year, for the rest of your life.  If you live to age 90, you would then have collected $1 M back from from the policy.  If you live to age 100, you’ll have collected  $1.5M.

All policies are different, so you should read the terms carefully, but many policies would simply keep your original $1 M investment when you died.  So if you die at age 71, you would have only receive $50,000 back from the insurance company for the $1 M you gave them.  They would make out very well on the policy.  This makes up for the people who live to age 100, and is the nature of insurance – they make lots of money from some policies to make up for the others where they lose money.  Some policies might reimburse your heirs a portion of the investment if you die before a certain age, but this is not a certainty.  Again, the are contracts between you and the insrance company and can all be different, so you should carefully read and understand the terms (and maybe have an attorney or CPA read the policy as well) before you buy anything.

 

Another popular type of annuity doesn’t pay right away, but instead starts to pay when you reach a specified age in the future.  These are useful if you’re worried about running out of money later in life.  For example, at age 50 you could buy a policy that starts to pay you a monthly amount at age 80.  The earlier you buy these policies, the less they cost for a given pay-out (since you’re taking a chance that you’ll never reach that age, plus you’re letting the insurance company use your money for all of those years).  These can be a very useful way to guarantee that you won’t be destitute should you live a long time.  They are also relatively inexpensive since there is a real possibility the insurance company may get to keep the money and never pay out anything.  The later in life the policy starts pa, the less it should cost.

While there are limited exceptions (insurance companies spend a lot of money doing calculations and making sure that they come out ahead), on average you’ll not do as well with an annuity as you would have had you invested on your own.  While you might be taking some of the insurance company’s money if you live to age 100, most people will not live past 85 or 90.  Taking the same example of a $1 M nest egg described above, if you had invested the money instead of buying an immediate annuity, a properly designed portfolio of stocks and bonds should allow you to withdraw about $30,000 – 40,000 per year for the rest of your life, indexed for inflation, without ever touching the principle.  This means you could have withdrawn about $1,050,000 between the ages of 70 and 90 and still have had $1.6 M to leave to your kids when you died.  This is compared to receiving $1 M from the annuity and having nothing to leave your kids.

If you lived to age 100, you’d have withdrawn about $1.8 M from the portfolio, versus receiving $1.5 M from the annuity, and now have $2 M to leave to your kids (which will buy what $1 M buys today).  Investing on your own, instead of buying an annuity, will generally result in you both receiving more income while you are alive and in you having more money to pass on to your kids.

So, with an annuity, you’re trading risk – the risk that you won’t invest well or that the markets just won’t cooperate – in exchange for giving up some return on your money.  The insurance company now takes on this risk and needs to find ways to invest the money to ensure that they have enough money to pay the policy holders while still making a reasonable profit.  They set their pay-outs in such a way to make sure that they cover this risk, on average, just like how set their car insurance rates high enough to cover claims and still make money.  The amount they pay is also generally fixed (for example, $50,000 per year), so your spending power will decrease over time due to inflation.

You may worry that an insurance company may charge you way too much for an annuity, resulting in a huge profit for them, but market forces should generally take care of this for you as long as you do your part and compare products from several different providers to get the best deal.  As long there are enough insurance companies out there competing for your business, you should get the maximum return possible with the insurance company making just enough money on your policy to pay the person who sold it to you, keep the lights on, and make a reasonable profit for their shareholders.  You’ll still be paying for all of this overhead, but that is what you are trading for the security of a monthly payment instead of the less unpredictable returns from an investment portfolio.  Just make sure you do your part and shop around for the best return, since once you buy in it is expensive to undo the deal, even when you can.

Realize also that people selling annuities to you generally make a commission from the sale, which both adds to the cost and makes them eager to sell you something, even if it isn’t the best thing for you.  Many of these salesmen know little about what they’re selling.  They just know what they’ve been told to tell you to get you to buy.  In general the choice to buy an annuity should be yours, not the result of a high-pressure sale, and you should take the time to read the policy and review it with whatever professionals you need to make sure you’re making a good decision.

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Some annuities also make offers of additional potential returns based on the stock market or come with other bells and whistles. While this may sound enticing, you’ll do better just buying a smaller annuity and investing the rest of the money yourself.  Remember that the insurance company needs to make money, so the returns they’ll provide will be well lower than market returns.  Only buy annuities when you want a guaranteed return, not as a way to invest in the stock market.

Finally, know that the guaranteed return from an annuity is only as good as the insurance company who you buy the policy with (and whomever they sell it to).  If we see another Great Depression, it is very likely that the insurance companies would all go broke and leave policy holders in the lurch.  Because they need to invest the money in the markets themselves, if most businesses are going bankrupt, they would not have the money to pay out the payments each year in a collapsing market.  Note that the supposed “great recession” was nothing like the Great Depression.  Luckily such market events happen fairly rarely.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What Are Growth and Value Funds?


This is part of a series of posts for an online class on how to use your investments to fund your retirement.  To find other posts in the series, select the category  “Retirement Investment Class” under “Retirement Investing” at the top.  The posts will appear in reverse order, with the newest post first. 

In the last post in this series, How to Evaluate Mutual Funds and ETFs, we briefly talked about the Style Box.  Today we’re going to go into a lot more depth on how to use this useful little tool for evaluating mutual funds and the concepts behind it.  This is one of the most important topics for determining how to determine your asset allocation.  Get this right and you’ll gain a couple of percentage points of return each year, which will translate into millions of dollars in a retirement account held over four decades or more.  It is still important in retirement investing as well, although how you allocate your money will be somewhat different.

Today we’ll discuss the style box typically used for stock mutual funds.  Bond funds use one as well, although the categories would be different.  A sample stock fund style box, taken from the description of one of Schwab’s mutual funds, is shown below.  On the bottom, horizontal axis, the investment style is shown, going from Value to Growth investing.  In the middle is Blend, which just means it is a combination of both Value and Growth investing.  On the vertical axis is the market cap, including small, mid, and large cap.  We’ll go over each of these categories.

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Investment Style

There are two main styles of investing, both of which have been applied successfully and both of which work well at different times.  The first is value investing, which is based on what is known as the Firm Foundation Theory.  The Firm Foundation Theory says that a stock has an appropriate price, or value, based upon the fundamentals of the company.  Stocks that have a price exceedingly below this value are considered inexpensive and likely to increase in price, while those that are priced way above this value are considered high in price and likely to decline back to the appropriate value.

People who are value investors would look at earnings, property, and the prospects for future earnings and determine a value for the company.  They might, for example, look at the price/earnings ratio, or PE, which is the price of the stock divided by earnings per share.  They would compare the PE value to both the historic range of values for the company and to the PE ratios of other companies in the same line of business.  They would seek to buy stocks that have a low PE, meaning that they are cheap compared to their value, and sell stocks they hold that have a high PE, meaning that they are expensive compared to their value.

Growth Investing involves finding stocks in companies that are growing rapidly and buying their shares.  This often involves finding the stocks that are reaching all-time highs and buying their shares, relying on the momentum of the company’s share price to continue.  Growth investors would look at things like earnings and dividend growth rate, the number of new stores that are being opened or the potential size of new business lines a company is creating.  They would tend to buy smaller companies that have potential to grow, shying away from companies like WalMart and McDonald’s that have already expanded greatly and would have difficulty doubling their earnings.

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Often value investors are buying stocks in companies that are having financial issues, which makes value investing slightly more risky than growth investing since some of the companies they’ll buy will not be able to turn things around and go bankrupt.  Growth investing also has a risk, however, since sometimes companies grow too fast, taking on debt while they do so, and end up needing to sell off assets and restructure. Growth investors are also buying shares of stock when they have already gone up in price, hoping that they will continue to go up, so they sometimes overpay for them.  Over the history of the US markets, value investing has outperformed growth investing on average but not always.  An exception is the period from 1980 through 2000, during which time growth was king.  Growth also outperformed value from 2008 through 2016, although value has done better during this last year.

Market Cap

Market cap, or market capitalization, is how large a company is.  Market cap is found by multiplying a stock’s price per share by the number of shares outstanding.  Small cap companies obviously have small market values, while large caps are huge enterprises like Home Depot and Google.  Small caps have more room to grow, given their small size, which means that they have a lot of growth opportunities, but large caps have the ability to get better pricing through concessions from vendors, as well as the ability to weather downturns by expanding into multiple business lines and/or parts of the world.  Mid caps fall between the nimble small companies and the Fortune 500 companies, but should be thought of as an extension of small caps since they tend to perform similarly.

Over long periods of time, small caps will outperform large caps since they have more room to grow.  The exception is turn-around companies that shed a lot of the old baggage and in a sense become new companies again.  During any given 10-year period small caps may outperform large caps, or large caps may outperform small caps, so you can never really be sure about which asset class would make the better investment.  If I were buying and holding for a 40-year period and had to choose one, I would buy small caps since they would grow more than large caps and outperform.  If I were holding for a 10-year period, however, I would probably choose large caps since they would likely hold up better should a business downturn occur since they have more cash reserves and financial stability.

 

Setting up a Portfolio

Now that we’ve discussed the style box and the different investing styles and market capitalizations, how does an investor put this to use?  In setting up a portfolio, you’ll  want to cover the full spectrum of investing styles and company sizes.  You don’t know which style and company size will perform best during any given period, so you want to invest in everything to make sure you are in the sector that is doing the best at any given time.  This means that you’ll never have all of your money in the sector that does the best and make the maximum possible returns, but it also means that you’ll never be entirely in the sector that is doing the worst and miss out on a good rally or bear the brunt of a big decline.  There is no way to know which sector will do the best over the next year or ten years, and attempting to guess will normally cause you to underperform the overall markets, so it is better to accept that some portions of your portfolio will always do worse than others in exchange for always having at least some of your money in the hot sector at any given time.  Just realize that those that lag now will probably lead in the future.

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So, you’ll want to buy funds that either cover the four corners of the style box or buy both small cap and large cap blended funds that include both growth stocks and value stocks.  You can also buy mid-cap stocks to further diversify your holdings.  You can also cover everything by buying a total market fund, which basically invests in everything, all in one fund.

If you are young, because value will outperform growth over long periods, and small caps will outperform large caps over equally long periods, you may want to skew your holdings slightly into these areas if you have decades to wait.  In doing so you’ll probably slightly outperform an evenly split portfolio, but not by much.  This becomes more important the longer the time period over which you are investing since small differences only add up to big money over long periods of time.  For those already in retirement, however, it is better to either split things evenly or even skew more to the large cap side due to their larger dividends and stability.  In the next post we’ll provide model portfolios based on these ideas and show how this is done.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Evaluate Mutual Funds and ETFs


This is part of a series of posts for an online class on how to use your investments to fund your retirement.  To find other posts in the series, select the category  “Retirement Investment Class” under “Retirement Investing” at the top of the page. 

In the last post in the series we discussed what mutual funds, index funds, and ETFs are.  Now that you are armed with this information, the question is then, “How do I select funds to invest in with all if the choices out there?”  Today we’ll cover how to determine what mutual funds invest in, which ones you’ll want to choose for a retirement investing plan, and how to select the best funds from a group of possibilities.

Probably the best source of information on a mutual fund is its prospectus, which can be found at the website for the fund family.  While there are a lot of fund families out there, you’ll want to choose one that features index funds, since those are the least expensive.  As we discussed in the last post, index funds will outperform most active fund managers.  Vanguard and Charles Schwab both feature several index funds.  Today we’ll look at funds from Schwab.  You can find a listing of their index funds here.

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As an example, let’s look at the Schwab S&P 500 Index fund , SWPPX.  Here are some of the elements to look at:

Fund Strategy

One thing we find in the description of the fund is the fund strategy.  This is a statement of what the fund manager is trying to do when investing and is the best way to identify funds that meets the various needs you’ll have when you invest.  The fund strategy will include things such as what types of assets (stocks, bonds, derivatives, etc…) the fund will invest in, whether the manager seeks to trade stocks for gains or to hold for long periods of time, and how actively the fund will be managed.  For the S&P 500 fund, we find the following information:

“Fund Strategy

The investment seeks to track the total return of the S&P 500-® Index. The fund generally invests at least 80% of its net assets in stocks that are included in the S&P 500-® Index. It generally gives the same weight to a given stock as the index does. The fund may invest in derivatives- principally futures contracts- and lend its securities to minimize the gap in performance that naturally exists between any index fund and its corresponding index. It may concentrate its investments in an industry or group of industries to the extent that its comparative index is also so concentrated.”

-SWPPX description from Schwab website

Since this is an index fund, the goal is to track the performance of the underlying index, good or bad.  Since the S&P500 Index is a list  50 large US stocks, this fund would be a way to get exposure to large US stocks.  It does this by actually investing in the stocks in the index.  The fund may also invest in derivatives instead of buying the stocks themselves, which could add to the risk of the investment, but in this case it is probably fairly safe due to the nature of the fund.  Here the manager is just trying to replicate the performance of the index, not to time the market using derivatives.

Performance Graph

On the first page of the fund description we find a chart showing the performance of the fund against the index it is trying to follow, the S&P 500 index:

The main purpose of looking at this element is to see how the fund has performed over the past several years in comparison to other funds and the relevant index.  Here you can see that the fund, SWPPX, has tracked the S&P 500  index very well.  An investment of $10,000 ten years ago into the fund would be worth $22,109 today, where an investment in the index (if you were able to do so) would be worth $22,199.  This is better than the $19,200 that an investment in the average large blend category would provide. This is the type of performance you want from an Index fund – close tracking of the index.

Fund Information

Also on the first page we find a table of general information about the fund:

The 52 week range gives you a general idea of how much the fund moves around in price.  Over the last year, it has moved about $9, or around 25% in price.  The YTD return shows how it has performed this year-to-date.  In this case it has increased about 22% because the S&P500 is having a good year.  A good YTD return isn’t always a good thing.  It is nice to see that a fund has done well when the markets have done well, but great performance last year may mean that the stocks in the fund are overbought and may not do as well next year.

The fund expenses are very important.  With the gross expense ratio and net expense ratio at 0.03%, this is a very inexpensive fund.  This is the percent of your investment that will go to fees each year.  For example, if a fund has a 1% expense ratio, you’d be paying $10 each year for every $1000 invested.  A typical managed fund will charge 1% or more.  An index fund will usually have fees between 0.25% and 0.5%.  You’ll generally want to find the cheapest funds you can find unless a more expensive fund invests in an area you can’t access otherwise.

The distribution yield is also important for retirement investing.  This fund pays a 1.65% yield, which means that you’ll receive a check for $1.65 for each $100 you have invested each year. You’ll want to have some funds that pay quite a bit more, like $5 or $8 for every $100 invested.  This would be a good fund to have in a taxable account that you wanted to hold and have compound, however, since it would generate very little income that would be subject to taxes each year.

The minimum investment shows how much you need to invest to buy into the fund the first time  (after that, you can generally invest whatever amount you wish).  In this case you only need to invest $1 to start, which again is very unusual since many funds require investments of $3000, $10,000, or more.  If you have a lot to invest, such as when you’re investing in a retirement account, the minimums won’t matter because usually meet them.  When you are just starting to invest when you’re young, however, they can be difficult to meet.

Golfer’s Multi-tool

Style box

Another critical element is the style box, which is created for each stock fund by a company called Morningstar.  One one side it shows the type of investing, value or growth.  The other side shows the the size of the assets held, going from small stocks to large stocks.  In general you’ll want to either have funds in all four corners of the box or funds at the top center (Large Blend) and bottom center (Small Blend) in your portfolio so that you cover all of the bases.  We’ll go more into the investment styles in the next post in this series.

 

BARSKA Blueline 8×22 Waterproof Golf Scope (Yards)

That covers the main elements you should use in evaluating a mutual fund or ETF.  Later in the series we’ll talk about gathering up your portfolio of funds, and then how to decide how much in each fund.  For now, just take a look through the data on a few funds.  You can also go to Vanguard and look at their funds, or go to Morningstar where you can get data on all sorts of funds.  If you have a question about what you find, please leave a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.