5 Mistakes That Sink A Retirement Plan

retirement plan

Retirement investing isn’t often about what you might do wrong, a sin of commission, but what you don’t do at all — the sin of omission.

What is a sin of omission? An inaction that you commit, and one that hurts really only you. After all, if you don’t save for your own retirement, who will?

The days of forced retirement investing through pensions is long gone. Social Security was always meant to be a safety net, a way to keep older Americans from falling into poverty by accident.

retirement plan

Neither system is perfect, but they had the very powerful feature of taking choice out of the matter. Pension plans require participation. Social Security taxes are not optional.

What can go wrong now? Consider these five mistakes, these sins of omission, that can sink a retirement plan:

Not saving at all

Seems like an obvious one, but an amazing percentage of Americans, roughly one in three, has saved literally nothing for retirement. Half of us own no retirement accounts whatsoever. Those with retirement savings accounts don’t have much, either, about $60,000 on average. Still, they’re doing better than the folks with zero.

Saving too little

We save about 5% of income as a nation. We carry debts that must be paid. Assuming normal economic growth and inflation rates, that’s a recipe for stagnation. Ten percent savings is a better target, and 15% is better still.

Starting too late

Many people put off retirement saving until they are well into their 40s. They pay for kids, for cars, they buy houses and vacations. They do anything but save and invest. But those years from the early 20s to about 40 are a huge boost to long-term returns. You need your money to be invested for decades if you expect it to grow into enough to retire.

Paying unnecessary taxes

You’ve heard it before. We’ll say it again. If you have a job with a 401(k) and don’t participate, you are paying taxes on income you could easily avoid. More than likely, you also are missing free money from your employer in the form of matching funds. If you don’t have a 401(k) but you do have a job or your own company, an IRA will achieve the same goal of paying less taxes now while saving more for retirement.

High fees

The omission here is not investigating ways to lower your investing costs. Principal among these is using index funds to own a portfolio of diversified investments. If you own mutual funds instead, you pay a high cost for management of that money, most likely. If you pay an advisor on top of that, it’s a double-whammy of costs upon costs.

You can fix these problems in about a week or two of visiting your HR department to see about your 401(k), setting up automated contributions, opening an IRA and looking into buying a small handful of index funds.

Inaction is the enemy here. Doing nothing is, in the end, the most expensive way to go.

7,728 Stocks To Watch In This Market

stocks to watch

The most common investment article you’ll find on the Internet is the basic stock tout. You’ve seen this one. “Six Stocks To Watch Now” or “Three Stocks Set To Pop” or similar headlines.

It’s called a “tout” because that’s the purpose of the article, to drive your interest toward the headline, get a click and pull you off into a website you might otherwise ignore.

If the promised article on stocks is there, it’s vague and very long. Then you have to enter an email address to get a “free report” that details the actual investments.

stocks to watch

Can six stocks make a difference to your long-term investment performance? Yes, of course. They could mean outperforming the broad market by a significant margin.

Owning just six stocks also might turn out to be the worst choice imaginable, too. The wrong six stocks might dramatically underperform the market or even go out out of business entirely and leave you broke.

The reason you diversify a portfolio is to greatly reduce the chance of losing all of your investment yet maintain the advantage of owning stocks at all, namely, price appreciation and dividends.

Over decades, stocks rise in price. They also generate steady dividend income, free money which can be reinvested. That reinvested income is why the long-term return on a stock portfolio greatly outperforms bonds, cash, gold and other investments.

And that’s why people own stocks. If you bought just one stock index fund, say, the Vanguard Total World Stock ETF (VT), you would own 7,728 stocks.

That’s nearly all of the stocks in the entire world considered “investable” at all. That one investment would spread your money across 46 countries, every type of economy and you would own companies in dozens of economic sectors.

Waves at the beach

You also would pull in a steady 2.26% yield from dividends, at recent pricing. Not bad in a world of rock-bottom interest rates.

More importantly, you don’t have to worry about which stocks to sell and which to buy. Owning a broad, index-style ETF means you get the rebalancing effect automatically as the fund buys and sells stocks to track its benchmark.

When you own something as broadly diversified as that, you should not expect to outperform anyone. But you won’t underperform, either. And the dividends just roll in like waves at the beach, lapping at the sand.

If you wanted to be a bit more aggressive — only a bit more — build a portfolio of ETFs that holds all of the major investment asset classes and rebalance them periodically. Just selling high and buying low is enough to grab extra return year in and year out.

The final reward is true calm, the ability to look right past the stock tout articles and pay attention to other things instead. That can be a huge relief for anyone concerned about investing their money correctly over the long term.

Ignore the touts and just buy it all. Years from now, you’ll be glad you did.

Investing Basics: Do I Need An Advisor?

do i need an advisor

Investment advice comes in many forms, with many purposes. Some of it is about budgeting, insurance and spending, some about actual investing for retirement.

But take a step back. Does everyone need a financial advisor? Surely there are millions more people out there trying to save and invest than there are advisors to serve them?

That’s true, and it’s okay. Not everyone needs or even wants an investment advisor. Here’s how to know if you need an advisor for your retirement portfolio.

do i need an advisor

Question No. 1: Are you comfortable with your basic understanding of money?

A lot of people know the ins and outs of savings and checking accounts, how interest rates affect home and vehicle loans, how to check their credit scores and file taxes.

Is that you? If yes, then you probably can handle the fundamentals of investing money for retirement. It’s important, for instance, to be able to read investment fund literature and grasp why one investment is higher or lower risk than another.

If you can manage these basic concepts, chances are you can manage your own retirement investing without having to pay for help.

Question No. 2: Are you financially literate, or at least a quick study?

Investing is not a game that holds still. No, you don’t need to starting watching cable money shows or read tons of newsletters (actually, you shouldn’t). Rather, you have be able to keep up on broad changes in how investing works.

A few decades ago, index funds didn’t exist. Same with exchange-traded funds (ETFs). Their impact on low-cost, long-term investing has been profound, and that trend continues.

Likewise, the benchmark interest rate is very low, still, and looks likely to stay low for a while longer. That affects investments across the board. You’ll need to be able to follow along and understand the impacts of such trends as they unfold over the years.

Question No. 3: Can you recognize when deeper advice might be worthwhile?

Everyone needs help sometime. Using software to create a portfolio is a great starting point for seeing the ideals of risk-adjusted investing put into practice.

Yet you might run into a situation where professional direction would be useful. Hiring an hourly fiduciary planner to advise you on taxes and insurance, for instance. If you can recognize the limits of your own abilities in the financial arena, then getting started on your own is less of a risk.

Nobody can do everything. But using good tools can get you a large part of the way toward a solid, responsible retirement investing plan. Whether you need an advisor or not is a question you can answer for yourself, assuming the basics are in place.

Why Investment Failures Are So Important

investment failures

A Princeton professor has made waves online by publishing his own resume of failures — grants he did not get, schools that turned him down. He’s not the first academic to do so, as he notes, but it’s an interesting exercise nonetheless.

The professor, Johannes Haushofer, took on this masochist effort not to punish himself but, as he put it, to give some perspective on his successes.

“Most of what I try fails, but these failures are often invisible, while the successes are visible. I have noticed that this sometimes gives others the impression that most things work out for me,” he wrote.

investment failures

It’s instructive to think about his approach to failure in terms of retirement investing. A lot of people think that the best approach is to buy a small number of investments and never sell.

Others take the view that you should try lots of things, getting in and out of the market often. After all, why spend months or years on investment failures when so many clear winners are out there to buy?

It’s counterintuitive, but you should do both: It’s important to buy investments and hold them for long periods and to avoid trading. But it’s also important to try to own the best-performing investments.

How do you know which are which? Here’s the beauty: You don’t have to know anything at all.

Portfolio investing is about owning asset classes, not individual stocks or bonds. Index funds allow investors to buy and hold whole markets. Since the funds rebalance automatically by market cap, you don’t have to worry about buying and selling.

Likewise, you don’t have to try to guess which asset class is going to do better or worse in the coming months or years. Rather, you just to be sure to own an appropriate amount of each investment type, be it stocks, bonds, real estate or commodities.

Over time, one investment class or another will surge ahead and be an obvious winner. When you go to rebalance, you end up taking those gains while they exist. The resulting cash is available to buy other investments that are down, relatively speaking.

That’s selling high to buy low, which is exactly how you should invest for long-term retirement planning.

Risky decisions

If you do it right, the long-term effect is to diminish the impact of your “failures” in comparison to your “successes.” In fact, the portfolio indexing strategy turns those relative failures into real successes over time.

More importantly, this approach erases the huge emotional risk entailed in focusing on individual investment failures. It also takes your attention off of relative successes, which can be important, too. You get to worry less.

And one more unseen risk: Nothing is worse for a long-term investment plan than a string of accidental “wins” early on in the process. It can give the young investor the impression of knowledge in a business that relies far more on chance, and that can lead to terribly risky decisions in the future.

Ignore Stock Market ‘Round Number’ Days

round number

The Dow Jones Industrial Average just surpassed 18,000 points, overcoming a hurdle of sorts. The market hasn’t hit that specific round number since last summer.

There was no shortage of commentary on the Internet on the big 18K number. And why not? It’s interesting, and that’s what news organizations are about, filling up airtime and empty web pages with mildly interesting facts between bouts of actual news.

round number

 

Should you care? Absolutely not, for a number of reasons:

1. It’s a fallacy to attach importance to round numbers. The Year 2000 came and went and we all got worked up over a supposed global computer shutdown. Remember that?

2. We pass interesting milestones all the time. Dividend yields rise and fall. Inflation consumes more or less of our total return. There are a lot of moving parts here that aren’t being taking into account.

3. Did you feel any different at 30? How about turning 40 or 50? Neither does anybody else.

4. Most importantly, number watching tends to lead to market-timing trades. And those can be truly dangerous.

Do you know for a fact that passing 18,000 on the Dow means we’ll hit 19,000 by year end? You can probably find “evidence” to back up that assertion, if you look for it.

Do you know for fact that passing 18,000 — or 17,000, or any round number — means we’ll soon see a major collapse in stocks back to some previous low, or even lower? Look for it, and you’ll find evidence to support this viewpoint too.

And that’s the problem. Both the round-number optimists and round-number pessimists are guessing. Just guessing.

There is some data somewhere to show either and both outcomes are possible. But there is no data anywhere that proves either outcome is guaranteed.

But let’s step back and just think about optimists vs. pessimists. It’s contrarian to say this, but at least some investors should see rising stock prices as bad news.

Young people, for instance, need a stock market that is tethered to reality. If the price of “getting in” to the stock market goes too high, their risk of a lower long-term return goes up.

Round number reality

An older person, of course, wants stocks to rise and never return to earth. Irrationally high stock prices mean they are richer, at least on paper.

Stock markets are, as Warren Buffett often points out, a voting machine in the short term and a weighing machine in the long term. That is, prices can be wrong, even very wrong, for a while.

But in time they correct to a realistic level and then usually build higher from there. Does it matter that we must passed a round number with a lot of zeroes after it? For the retirement investor serious about building a portfolio, not at all.

What matters is owning stocks consistently, rebalancing periodically and adjusting that portfolio to avoid unnecessary risk as you get age. Round numbers in the stock market are a distraction, a passing headline — and nothing more.

Take An Easy Financial Fitness Quiz

financial fitness

You sweat the extra pounds, eat around the calorie-filled holidays, even time your steps with a newfangled fitness watch. But are you financially fit?

Your financial fitness is not as simple as having an extra few hundred bucks in your checking account and all your bills paid up. That’s a great place to be at 20 years of age, but not at 30 or 40.

financial fitness

Take this easy financial fitness quiz and see if your money life is on track. (Hint: In every case, “C” is the wrong answer):

1. Do you have a 401(k), IRA or other tax-deferred plan through your work?

A. Yep, and it’s funded to the max!

B. I opened it, but I just put in a little, whatever the default is.

C. I might have missed that meeting with human resources.

2. Do you have enough money in the bank right now to pay your bills for the month?

A. Easily, plus the next four to five months if I stretch a little.

B. Maybe? I’d have to check, but I’m confident no bills will go unpaid.

C. I probably don’t have enough cash to buy food for the next week. But I have a credit card, so no problem!

3. Speaking of credit cards…is your credit rating good, bad or ugly?

A. I have “good” or “excellent” credit, no late payments ever and check my credit report at least annually.

B. I’m working on my creditworthiness, but it has been a struggle in the past. I should check it more often, I suppose.

C. Next question, please.

4. If I had a surprise medical cost or other financial emergency tomorrow, I would pay for it by:

A. Dipping into savings with room to spare.

B. Some savings, but maybe borrowing against my home.

C. Hitting up friends and family, maybe letting the bills ride in the meantime.

5. My idea of “enough” for retirement looks like:

A. Social Security plus income from my retirement savings prudently invested for the long run to produce income that matches my realistic cost of living.

B. I plan to work past 65, but mostly that’s to make sure my plan will work out.

C. I will not retire. I have made my peace with that fact.

6. If something happened to me tomorrow, my loved ones can expect:

A. To receive an insurance check that should make up for a decade or more of my lost income.

B. Burial coverage through my work and whatever Social Security will pay out to them.

C. To have to hire a CPA to untangle my accounts and help them figure out how much debt they’re in.

7. My idea of the purpose of money is:

A. Freedom from stress and worry. Truly a means to an end, not just means in the financial sense.

B. To pay for things, since things are the most reasonable measure of wealth.

C. I’ve never thought about it. Money doesn’t stick around long enough for me to have an opinion.

If it isn’t obvious yet, the better choices here are “A” down the board. If you find yourself split between “A” and “B” on your responses, focus on the weak spots and build up your knowledge.

If you’re a solid “C,” time to get cracking and perhaps hire a financial planner to help.

Retirement: Is Your Glass Half-Full?

rich

One of the fundamental premises of retirement saving is prudent compounding. Now, before your eyes glaze over completely, consider two perspectives:

Glass half-full? Half-empty? Which person is doing “better” at saving for retirement?

rich

It’s a trick question: They’re in essentially the same place. Yes, Blake has more money. He also probably makes more and saves about twice what Sally is saving.

But Sally has something Blake does not have and cannot make more of. She has time. And that’s the point about prudent compounding.

Money properly invested will double in value within a certain number of years. Most advisors and planners think of 10% growth as a typical year for the stock market.

Yet they know that most investors cannot stomach the ups and downs of a 100% stock-only portfolio. So, they leaven the mix with bonds and other investments that grow more slowly but do so more surely.

How fast will your money compound? Finance folks like to talk about the Rule of 72, which states that if you know the interest rate and divide it into 72, you can solve for the number of years it takes money to double.

If you think 10% is a reasonable assumption, then you take 72/10 and get 7.2 years to double your money.

Likewise, if you assume something closer to the return on a bond portfolio, around 4%, then the equation becomes 72/4 and you get 18. It will take 18 years for your money to double at that rate of return.

Sally is better off in a mostly stock portfolio. She has more time for money to compound and can likely ignore a sharp decline or two over the decades.

Blake is in a tougher spot. He needs his money to grow but likely cannot handle a major downturn. His emotions might get the better of him.

Prudence and risk

That’s the prudent part. What is the right mix of investments for the goal you seek to achieve, considering how you might react to straying off course? That mix is what is “prudent” for you.

Prudent investing for retirement is about doubling your money as quickly as possible while not taking on risks you cannot accept. Then, once the money has doubled, doubling it again and again.

After a certain point, your idea of what risk means will change. The larger the balance, the more likely you are to seek less-volatile investments. And that’s fine, so long as you make it to your goals and retire in the manner you expect.

Saving For Retirement: Is Your Glass Half Full?

One of the fundamental premises of retirement saving is prudent compounding. Now, before your eyes glaze over completely, consider two perspectives:

Glass half-full? Half-empty? Which person is doing “better” at saving for retirement?

It’s a trick question: They’re in essentially the same place. Yes, Blake has more money. He also probably makes more and saves about twice what Sally is saving.

But Sally has something Blake does not have and cannot make more of. She has time. And that’s the point about prudent compounding.

Money properly invested will double in value within a certain number of years. Most advisors and planners think of 10% growth as a typical year for the stock market.

Yet they know that most investors cannot stomach the ups and downs of a 100% stock-only portfolio. So, they leaven the mix with bonds and other investments that grow more slowly but do so more surely.

How fast will your money compound? Finance folks like to talk about the Rule of 72, which states that if you know the interest rate and divide it into 72, you can solve for the number of years it takes money to double.

If you think 10% is a reasonable assumption, then you take 72/10 and get 7.2 years to double your money.

Likewise, if you assume something closer to the return on a bond portfolio, around 4%, then the equation becomes 72/4 and you get 18. It will take 18 years for your money to double at that rate of return.

Sally is better off in a mostly stock portfolio. She has more time for money to compound and can likely ignore a sharp decline or two over the decades.

Blake is in a tougher spot. He needs his money to grow but likely cannot handle a major downturn. His emotions might get the better of him.

Prudence and risk

That’s the prudent part. What is the right mix of investments for the goal you seek to achieve, considering how you might react to straying off course? That mix is what is “prudent” for you.

Prudent investing for retirement is about doubling your money as quickly as possible while not taking on risks you cannot accept. Then, once the money has doubled, doubling it again and again.

After a certain point, your idea of what risk means will change. The larger the balance, the more likely you are to seek less-volatile investments. And that’s fine, so long as you make it to your goals and retire in the manner you expect.

Investing Basics: What Is Inflation?

what is inflation

Inflation, a good thing or a bad thing? The answer, strangely enough, is “both” and how you react to inflation can deeply affect your retirement investment planning.

First of all, what is inflation? Inflation is nothing more than rising prices. We all know intuitively that things will cost more in the future. The price of energy and food goes up and down pretty quickly, but the average price for most things steadily rises over time.

How fast is the issue. Economists want “healthy” inflation of about 2% and generally accept long-term inflation of perhaps 3%.

what is inflation

Slowly but steadily rising prices are a sign of a growing economy. It signals demand for goods and services that slightly exceeds the available supply.

Over time, demand can slip. When it falls consistently, we tend to worry that a recession has begun, that the economy itself is shrinking.

The opposite can happen, too. Demand can outpace supply dramatically, causing prices to rise more quickly than expected.

The Federal Reserve has tools at its disposal to tamp down inflation or, as in recent years, attempt to keep inflation rising even if the economy is weak. For the retirement investor, these short-run moves by the Fed aren’t important.

What matters is finding investments that provide a return that exceeds inflation over many years. The return you get from the stock market might be 9%, but subtract 3% inflation and your actual purchasing power is growing by 6%.

That’s called “real return,” and it’s the goal of retirement investors to keep that number positive. Your money is likely to double in value — that is, to compound — so long as the real return is high enough. A long run of below-par investment returns isn’t a help if inflation is eating the value of that money along the way, too.

What is inflation risk?

When financial advisors talk about risk, one of the factors that they include is inflation risk, put simply the risk that inflation will grow faster than your expected investment returns. In that scenario your savings actually lose value, despite being invested.

Investors offset inflation risk by making sure that their portfolios include a healthy dollop of growth investments, such as common stocks. While stocks are more volatile than bonds or real estate, they do tend to grow faster than inflation over the years.

A retirement portfolio balances the risk of loss from stock investing against the equally complex risk of purchasing-power loss due to inflation. Keep both risks in check is the job of a well-designed portfolio.

Diversification and rebalancing are the final pieces of the puzzle. Inflation is inevitable and, to a degree, desirable for the economy at large. Just don’t let it become an unacceptable risk to your long-term retirement planning.

When To Use ETFs, When To Avoid Them

when to use etfs

Exchange-traded funds (ETFs) get a strangely bad rap in the investment press. They’re either too risky or too boring, too opaque or too obvious.

Which should lead you to a simple enough conclusion: In most cases and for most investors, they are just right. That’s because a broadly diversified ETF simply reflects the market index it tracks.

You could go out and buy all 500 stocks in the S&P 500, but why? You could pay an active fund manager an exorbitant feet to replicate the stock market, but why?

when to use etfs

Why indeed, if an ETF gives you the reliable exposure you want at a very low price. Nevertheless, when to use ETFs is a reasonable question, as is when to avoid them.

The simple answer is: Use ETFs to own an asset class, such as stocks, bonds, foreign equities, real estate or commodities.

If you know you want a piece of that market but you don’t know which stocks to buy, don’t try to figure it out. Just own the ETF and you own the whole market.

The thing is, study after study has shown that actively managed funds simply can’t keep up with their indexes. Trading tactics go in an out of fashion.

Sometimes managers make brilliant strategic moves and clean up relative the whole market. And sometimes they just blow up.

What follows next is the quiet closing of that fund, then the company that offered it just moves whatever is left of investors’ cash into a similar fund in the same family.

Both the out-sized win and the horrific mistake should seen for what they are — random chance. The manager who “guesses right” on the movement of the market is still guessing.

Funny thing is, he gets paid right or wrong. If actively managed funds had to survive on a percentage of their performance above the benchmark, most would go out of business in no time.

Eventually, even the “winners” would slip up, and all that would be left would be the indexes. That’s why so many billions of retirement dollars are moving steadily toward passive investment portfolios, often using ETFs.

When to use ETFs

When should you avoid ETFs? When an ETF doesn’t do the one simple thing they do well, which is track a major index at a low cost.

You can find ETFs out there that do — or at least claim to do — just about anything. Double the inverse of the price of oil. Twice the performance of the dollar against foreign currencies. Frontier-stock ETFs that track nascent economies such as Mongolia.

In short, if you wouldn’t put your money into given investment as a single stock, the ETF version of that idea is not “more safe” by virtue of being an ETF. Some of these ideas might work out, but most will collapse under their own weight.

When to use ETFs is when you understand the investment and its history very well, you know the track record of the company offering the fund, and you have money to invest for long periods of time — then and only then, an ETF is a great retirement tool.

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