Managing Your Money in Retirement


 

 


This afternoon I got into a conversation with a friend about money management in retirement.  He has the opportunity to take a pension as an annuity, or to take a lump sum and invest it himself and was wondering about which path was better.  He also has a couple of different 401k funds.  He was wondering if he should go to a financial planner, or just invest himself.

One thing about personal finance is that it is just that – personal.  The right answer for you depends on your financial situation, plans in retirement, and risk aversion.  If you are in great financial shape with way more money than you need, you can take more risk since you could take a big market drop without getting into trouble.  If you are planning to sit around the house in retirement and are scared of the prospect of losing any money, you might invest the money very conservatively and give up better returns in exchange for stability and predictability.  So there is no right answer for everyone.

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Personally, I have a great deal of experience and knowledge about investing, having invested for the last 30 plus years.  I was investing during the 1987 crash where the Dow Jones Industrial Average fell 25% in one day.  While it was quite a shock to see your stocks fall by 25%, or even get cut in half in a single day, I held on and saw prices recover to pre-crash levels within about a year.  I also was investing through the dot-com bust in 2000 (and shorting some dot-com stocks and oil refineries) and the housing bust in 2008 (and shorting some thrifts and housing lenders).

I’ve learned from this experience that things can go really badly in a short amount of time and that sometimes it seems like everything is going to zero.  I’ve also learned, however, that things usually turn out OK if you just hold on, at least if you hold onto a set of mutual funds or a whole basket of stocks.  Sometimes with individual stocks, they do go down and never go back up again.  These experiences have taught me both that volatility can be scary and that sometimes the best course of action is just to turn it all off and do other things since doing nothing is better than doing something.  They have also taught me that I do have strong nerves and can weather a downturn without freaking out and going into all cash.

 

 

Based on this experience, I will handle my own investing when I retire and use the markets to provide the income I need.  I know how to allocate the funding to provide the right amount of diversification and income at the right times.   I also plan to have way more in my retirement accounts than the minimum I need so that I can invest more aggressively without worrying about a big market drop affecting my lifestyle.

For other people, an annuity may make sense since it takes away the worry about finding needed income.  An annuity provides guaranteed income for a specified period of time.  The best types of annuities to buy are the plain-vanilla types where you give them a specified amount of money and they provide you with a specified income.  The other types where you can make additional returns based upon the performance of the stock market are just too complicated.  Realize that the returns you’ll receive will be far less than market returns since the insurance company needs to protect themselves for the years where the markets decline since they guarantee that you can’t lose money.  This means you’ll make 5% when the stock markets are providing 15% returns.  You’re better off just using an annuity for income and then investing some of your money in index funds for stock market participation.

The main issue with annuities is that they have a lot of fees attached, and those fees are often difficult to sort out.  Annuity salesmen are like whole life salesmen, using all sorts of jargon to sell you a really overpriced product.  This is why you want to keep it simple.  You’ll also want to ask three or four different providers how much monthly income you’ll get over a specified amount of time if you provide them a specified amount of money and compare the answers.  For example, if you have $500,000 to give them for an annuity that will start paying immediately and pay you until you die, ask each provider how much you’ll receive each month.  The one who will pay you the most per month, for the same amount invested and the same term, will be charging the lowest fees.  If they won’t give you a straight answer on what they’ll pay, move onto another provider.

                  

 

On the question of whether to invest yourself or hire a professional financial planner, I obviously plan to handle things myself since I know what I’m doing and really how little maintenance it takes to manage your money when you’re doing it right.  Really, less is more when it comes to investing.  I will still use other professionals like CPA’s, however, to help with the tax planning since that is an area that changes often.

Really, you could do very well on the investing side simply following three rules-of-thumb:

  1.  Invest your age minus 10% in bonds, and the rest in stocks.
  2. Invest in low-cost, diversified, index mutual funds.
  3. Take no more than 3% of the value of your portfolio out in any given year.

The first rule causes you to protect a portion of your portfolio from the wild ride that stocks can offer by tempering it with bonds.  As you get older and have less time to recover from a big stock market crash, you buy more bonds.  The second rule makes sure you spread out your money over the whole market (a total market stock and bond fund can be used to ensure this) and also to limit fees by investing in index funds.  The third rule makes sure you don’t take more out of your portfolio than it can replace while also keeping up with inflation.

 

For others, it makes sense to use a financial planner, but you need to be careful because there are a lot of bad financial planners out there.  Many simply take a short course on the products offered by their company and then spend their time selling you those products.  Even if you want to use a financial planner, it is better to at least have a basic knowledge of retirement investing before you go so that you can see if the person you’re dealing with knows what they’re doing or if they’re just trying to sell you something.  Buy and read a couple of books, and start to read articles in The WallStreet Journal and, of course, The Small Investor to learn what you’re doing.  You’ll also want to find a fee-only planner, who charges you by the visit or by the hour instead of charging you when you buy products from him/her.  You don’t want them to have an incentive to sell you things, other than knowledge.

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.

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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.

How Long Would It Take to Be A Millionaire


 

How long would it take you to becoming a millionaire?  Well, I used an investment calculator to determine at what age you would become a millionaire if you invested different amounts, from $200 per month to $1000 per month, starting at age 20.  Here’s the results:

Monthly Savings 10% Return 15% Return
$200.00 59 49
$500.00 50 43
$750.00 46 40
$1,000.00 43 38

So if you put $200 per month away ($2400 per year) into stocks and saw another period like the 1980’s and 1990’s, you would become a millionaire somewhere in your early 50’s.  If you put away $1,000 per month, or $12,000 per year, you would become a millionaire at age 43 even if you just got modest, average returns from the markets.  If you could get a 15% return, you’d be there are age 38, just 18 years later.

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Note that $12,000 per year for 18 years is $216,000, which is what you could easily pay at a private, four-year college.  If you then left the money invested, and were able to earn 12% annualized, you would have a cool $12M at retirement with no effort on your part.  On the other hand, if you earned $200,000 per year at a job because you went to an elite college from age 20 to age 65, you would earn only $9M over your working lifetime.  Just saying….

Be sure to check out this month’s book, The Bogleheads’ Guide to Investing.  

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @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.

Ways to Maximize Your 401k Returns


Basic 401k investing is easy and can be done with a target date fund or by calculating your growth/income split and investing in a total stock market fund and a total bond market fund.  (For details, see Simple Ways to Invest in your 401k.)  If you take this road, you can have yourself in good shape when retirement time rolls around while spending maybe 5-10 hours over your whole life setting things up and making adjustments.  This is predicated on your putting away 10-15% of your paycheck each month into your 401k.  Money doesn’t magically appear without an investment.

But what if you’re willing to spend a little more time learning and twiddling with your account.  How can you really maximize your returns?  If you take the basic route, you’re probably going to end up making an annualized return somewhere between 8 and 10% over your working lifetime.  Optimize things and you may get between 10 and 12%.  How much does an extra 2% matter?  At 8%, investing $400 per month, you’ll end up with $2.3 M between starting work at age 20 and retirement at age 67.  At 10%, you’ll have $4.6 M.  If you could get 12% or 15%, you’d have $9.1 M and $26.1 M, respectively,  Would you spend an extra couple of hours per year to gain between $2 M and $24 M?  I sure would!

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Now that I’ve got you interested, what are the things to do to maximize your returns?  Well, here they are:

1.  Don’t overwork things.

Normally, this would be the last item discussed, but it is so important it needs to be said up front.  Doing a little bit of adjusting and fine-tuning is good, but constantly moving money around will reduce your returns to the point where you may not even get the 6% to 8% you would get in a target date retirement fund.  It is best to accept that you cannot time the markets and that you do not know anything that is not already priced into the markets at any given time.  It is best to continue to follow the same strategy regardless of what the markets are doing.

2.  Concentrate in stocks.

Adding bonds will reduce the level of volatility in your account, but it will also reduce your returns since bonds do not perform as well as stocks over long periods of time.  When you get close to retirement age, or if bond yields climb into the teens because of high-interest rates, taking up a bond position makes sense.  Between the ages of 16 and 55, especially with yields at current levels which are near all-time lows, staying in all stocks, or maybe all stocks and REITs, is the way to go.

 

 


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3.  Overweight small

Small companies have room to grow because they are small.  It is far easier for the pizza place down the street with three locations to double their store count and their earnings than it would be for McDonald’s to do the same.  For this reason, small stocks will do a little better over long periods of time than will big stocks.  Over any given year or period of three years is anyone’s guess, since sometimes large-caps outperform and other times small-caps outperform.

4. Go international.

The US is a great place to invest due to stability and good property rights, but it is not the only game in town.  There will be times when international markets perform better.  You should, therefore, include some international stocks in your portfolio.

5.  Stick with indexes.

Study after study has shown that all stock funds perform about the same with the only real difference being the fees that are charged and expenses due to trading inside of the fund.  You, therefore, get the best returns when you find funds that have low costs and do not trade very often, which means you want unmanaged funds.  Index funds fit the bill.


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Given the rules above: Don’t overwork things, 2) Concentrate in stocks, 3) Overweight small, 4) Go international, and 5) Stick with indexes, an optimized portfolio for someone between the ages of 16 and 55 might look like the following:

Large-cap index fund (e.g., S&P500 index fund) 30%

Small-cap index fund (e.g., Vanguard Small-Cap Index) 40%

International stock fund (e.g., Vanguard Total International Stock Index) 20%

REIT Fund (e.g., Vanguard REIT Fund) 10%

You would set up your contributions to follow the percentages shown above.

Over time it is likely that one or two of the funds would outperform the others for short periods of time.  For example, during a stock market slump the REIT might hold its ground or even increase while the stock funds decrease.  That might make the portfolio overweighted in the REIT, with the portion in the REIT at 15% instead of the targeted 10%.   To correct this, go into the portfolio a couple of times per year and rebalance by shifting money from those funds that are overweighted into those that are underweighted.  Often mutual fund companies have tools to allow you to adjust your investments to match your contribution percentages in just one click, so all you need to do is find the right button on their website.

When you are rebalancing, what you are doing is selling funds that have done well (selling high) and buying those that have not done as well (buying low).  This is exactly the opposite of what you are doing when you look through the choice of funds in your 401k plan and pick those that have done the best over the last year or five years or buy the funds that have the most stars at Morningstar, but this is what most people do.  This is why it is important not to try to time the market or chase the hot funds.

Note that you do not want to rebalance too often since rallies tend to lift stocks well beyond justifiable levels and declines tend to lower price below reasonable levels.  This is called momentum, where investors buy stocks because they are going up and sell them because they are going down.  Rebalancing once or twice a year is about right. Good dates to pick are just after the new year (since stocks tend to rally at the end of the year as year-end bonuses get invested) and in the late spring since markets tend to do nothing in the summer months while people are on vacation.  Late fall is another possibility since big declines tend to happen in September or October.

You might also rebalance after the market has had a big run-up and started to lose steam, or after a big drop once prices have started to stabilize.  You’ll never get things perfect, so don’t expect to sell at a top or buy at a bottom.

New to investing? Want to learn how to use investing to supercharge your road to financial freedom?  Get the book: SmallIvy Book of Investing: Book1: Investing to Grow Wealthy

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @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.