Saturday, January 19, 2013

Retirement Moolah Accumulation

From the New York Times.

If you're perfectly capable of running your own retirement savings, selecting the right mix of low-cost investments, rebalancing at the right time and not buying and selling out of fear or greed, then good for you.

But the majority of people — maybe the vast majority — are not like that. They may be smart enough to do the right thing, in theory, but they forget or slip up or are taken in by well-meaning friends bearing stock tips or annuity-peddling scoundrels who make nice to them over free steak dinners. ...

According to the Department of Labor, the professionals who run pension plans earned an 8.3 percent annual return from 1991 to 2010. People fending for themselves in 401(k) and similar plans earned 7.2 percent. Nationwide I.R.A. performance figures are more scarce, though one 2006 study by the Center for Retirement Research put the figure for 1998 to 2003 at 3.8 percent annually, roughly 2 to 3 percentage points worse than pension fund managers and 401(k) investors did during that same period.

These numbers are a bit squishy, given that pensions often make bets in markets that 401(k) investors can't access and the high fees that many 401(k) participants pay that pension managers don't. Still, there are about a thousand reasons plenty of do-it-yourselfers (who, after all, did not volunteer to manage their retirement money) would be likely to get worse returns than, say, pension managers.

I've been involved with the TAG 401(k) Plan for seventeen years, and based on day-to-day experience, I think it's possible for individuals to handle their own investments without a huge store of investment knowledge, or spending a boatload of money.

What 401(k) participants need are some basic facts and discipline. They also need to know that passive investing with low-cost index funds has been proven to be a winner.

When Investing Remember That
1) Time is Your Friend
2) Broad diversification is beneficial (both stock AND bonds)
3) Low costs are important.
4) "Chasing performance" is a no-no.

After years of doing not-smart things, I've settled on investment guru Larry Swedroe's approach to investing.

1) Short term/intermediate term treasury and investment grade bonds.
2) Small cap value equity funds

As Mr. Swedroe says:

In years like 2011 when Small Value equities do poorly (not relatively poorly but negative returns) that is when bonds likely do very well and if you do it my way (lowering beta and increasing bonds) you lose more on your full value tilt but make more on your larger bond portfolio!!!!

Never think of these things in isolation. So in 2011, the full tilt really hurt the [small cap] equity side, but full tilt allows for very low equity exposure and bonds did very well, so portfolio did not do so poorly ...

The Mrs. and I now own a bond-weighted portfolio (We're of an age where it's prudent to do that anyway) with a strong tilt to small-cap value stocks. Research has shown that SCV provides higher returns over time than large cap stocks. And we've minimized our costs by investing in bargain-priced index funds.

The main point I've learned? Anyone investing for retirement needs to develop a plan and stick with it.

Weighting to large company stocks in a Total Stock Market of Large Cap index is perfectly fine.

Weighting to small and mid-size stock indexes is also good.

What's important is to map an approach that's palatable for you and commit to it. (This is harder to do than it sounds. Too many folks -- and I've known several -- chase after the latest hot trend and live to regret it. Tech stocks in the nineties would be one good example of this. They had HUGE returns for most of the nineties, then lost 80% of their value in 2001-2003.)

The big take-away:

There is no perfect. Just map out a good plan and stick with it. You'll beat ninety percent of investors.


Celshader said...

There is no perfect. Just map out a good plan and stick with it. You'll beat ninety percent of investors.

True. For what it's worth, here's some of what I've learned over the years...

1) Saving comes first. You can't invest money if you have not saved it.

2) The more you save, the more you'll have. For the same given time period, the artist who saves $10,000/year in I-Bonds will likely retire with more savings than the artist who saves $1000/year in a 401(k). The artist who manages to max out 401(k)/IRA contributions and I-Bond purchases each year will have even more.

3) It's OK to save for retirement outside retirement accounts. If your employer does not offer a 401(k) (a problem common in VFX shops), you are not limited to saving the max contribution to an IRA each year. After topping off an IRA, you can invest additional retirement savings in tax-deferred I-Bonds and fully taxable accounts (ex: bank CDs, tax-efficient Vanguard mutual funds).

For VFX artists, I have a fourth tip:

4) After maxing out all available retirement accounts, consider putting additional retirement savings in I-Bonds first. The biggest risk with I-Bonds is that the money is locked for up to one year (11 months if you purchase the I-Bonds a few business days before the end of the month). After that year passes, the I-Bonds can double as inflation-proof cash reserves in case of emergencies.

Steve Hulett said...

You can build fine tax efficient investments outside of 401(k) plans and IRAs.

Vanguard Total Stock Market Fund (domestic)
Vanguard International Stock Index Fund
Vanguard Intermediate Tax Exempt Bones

The disadvantage to doing this is: you get less tax-favored treatment from federal and state tax law. (And no pre-tax dollars into your investments.)

The advantage to doing this is you can tap into the money when you need it., without tax penalties T he investments will be taxed as capital gains, not income.

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