Investing Curiouscatblog

Category: Saving

  • 401(k) Options – Seek Low Expenses

    401(k), IRAs and 403(b) retirement accounts are a very smart way to invest in your future. The tax deferral is a huge benefit. And with Roth IRAs and Roth 401(k)s you can even get tax exempt distributions when you retire – which is a huge benefit. Especially if you don’t retire before the bill for all the delayed taxes of the last 20 years starts to be paid. The supposed “tax cuts” that merely shifted taxes from those spending money the last 10 years to those that have to pay for all the stuff the government spent on them has to be paid for. And that will likely happen with higher tax rates courtesy of the last 10 years of not paying the taxes to pay for what the government was spending.

    When looking at your 401(k) and 403(b) investment options be sure to pay close attention to expenses for the funds. Some fund families try to get people to investing in high expense funds, that are nearly identical to low expense funds. The investor losses big and the fund companies take big profits. Those people serving on the boards of those funds should be fired. They obviously are not managing with the investors interests at heart (as they are obligated to do – they are suppose to represent the investors in the funds not the friends they have making money off the investors).

    Here is an example (that I ran across last week) expense differences for funds that have essentially identical investment objectives and plans in the same retirement plan options: .39% (a respectable rate, though more than it really should be) for [seeks a favorable long-term rate of return from a diversified portfolio selected to track the overall market for common stocks publicly traded in the U.S., as represented by a broad stock market index.], .86% [for “The account seeks a favorable long-term total return, mainly from capital appreciation, by investing primarily in a portfolio of equity securities selected to track the overall U.S. equity markets based on a market index.”]. Do not rely on your fund provider to have your interests at heart (and unfortunately many companies don’t seek the best investment options for their employees either).

    The .47% added expense isn’t much to miss for 1 year. However, over the life of your retirement account, this is tens of thousands of dollars you will lose just with this one mistake. Personal financial literacy is an easy way to make yourself large amounts of money over the long term. It isn’t very sexy to get .47% extra every year but it is extremely rewarding.

    $200,000 at 6% for 25 years grows to $858,000
    $200,000 at 6.47% for 25 years grows to $958,000

    So in this case, $100,000 for you, instead of just paying the fund company a bit extra every year to let them add to their McMansions. In reality it will be much more than a $100,000 mistake for you if you save enough for retirement. But if you save far too little (as most people do) one advantage is the mistake will be less costly because your low retirement account value reduces the loss you will take.

    Related: 401(k)s are a Great Way to Save for Retirement – Retirement Savings Allocation for 2010 – Many Retirees Face Prospect of Outliving Savings
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  • Consumers Continue to Slowly Reduce Their Debt Level

    Consumer debt decreased at an annual rate of 3.25% in the second quarter. Revolving credit (credit card debt) decreased at an annual rate of 9.5%, and nonrevolving credit (car loans…) was about unchanged.

    Revolving consumer debt now stands at $827 billion down $39 billion this year. That is on top of a $92 decline in 2009. Hopefully we can continue this success.

    Through June of 2010 total outstanding consumer debt was $2,419 billion, a decline of $30 billion ($21 billion of the decline was in the 2nd quarter). This still leaves over $8,000 in consumer debt for every person in the USA and $20,000 per family.

    Consumer debt grew by about $100 billion each year from 2004 through 2007. In 2009 consumer debt declined over $100 billion so far: from $2,561 billion to $2,449 billion.

    The huge amount of outstanding consumer and government debt remains a burden for the economy. At least some progress is being made to decrease consumer debt.

    Those living in USA have consumed far more than they have produced for decades. That is not sustainable. You don’t fix this problem by encouraging more spending and borrowing: either by the government or by consumers. The long term problem for the USA economy is that people have consuming more than they have been producing.

    Thankfully over the last year at least consumer debt has been declining, but it needs to decline more. I disagree with those that want to see short term improvement in the economy powered by consumer debt. It would be nice to see improvement to the current economy. But we can’t afford to achieve that with more debt. Government debt has been exploding so unfortunately that problem has continued to get worse.

    Data from the federal reserve.

    Related: Consumer Debt Declined a Record $21.5 Billion in July – The USA Economy Needs to Reduce Personal and Government Debt

  • Bogle on the Stock Market and Investing

    Bogle on Bankers, Buffett, Obama; an interview of John Bogle, from February 2010.

    Bogle: What happened over the last 10 years were two things, and one of which we have never encountered before. The 17% returns we had over the two previous consecutive decades, the ’80s and the ’90s, were born largely on ascending price-earnings multiples. If the price-to-earnings ratio goes from 8 to 16 in one decade, and then to 32 in the next decade, that accounts for 7% per year of that 17% return. So the market was driven by the revaluation of corporate America and that just can’t keep recurring at those rates. I projected in the original book that the price-earnings multiple might get down below 20, which is exactly what it’s done, so that was fairly predictable.

    But what made the decade quite so bad is that we then had a major recession or light depression at the end of 2008 to 2009 which is still with us. That coming with the market so highly valued meant that earnings growth was much less than what we might have expected. So looking out from here, I think we can look for better earnings growth. And dividend yields are back in decent territory but not great. We started this decade with a 1% dividend yield, and that’s an important part of investment returns, and now the dividend yield is around 2.25%, so a higher dividend yield contributing to future growth. So I think it’s highly likely that stocks will outpace bonds in the decade that just began.
    …
    Are we on the right path now? Has America learned its lesson?
    Bogle: No. Unequivocally not. The long overdue reforms being discussed in Washington do not go nearly far enough, in my opinion. We need protection for consumers. Canada has a financial structure similar to ours except it has a consumer-protection board, which would prevent banks from giving people mortgages if they have no ability to pay them back. To get that done has been very difficult. Also, Senators (John) McCain and (Maria) Cantwell have proposed a return of the Glass-Steagall Act, and that’s gotten nowhere but it is long overdue. We should have banks behave as banks and not as investment banks or hedge-fund managers.
    …
    But let’s suppose the stock market creates a 10% return. And the value of the stock market today is around $13 trillion so 10% is $1.3 trillion. By my numbers, Wall Street and the mutual fund industry take $600 billion a year out of that return. That’s half of the return. So the only way investors are going to get their fair share of the $1.3 trillion is to reduce the costs and get the casinos out.

    As usually John Bogle provides excellent analysis and vision.

    Related: Bogle on the Retirement Crisis – Is Trying to Beat the Market Foolish? – Lazy Portfolios Seven-year Winning Streak – Sneaky Fees

  • The 4% Rule is Overly Simplistic

    Time to replace the 4% rule

    Conventional wisdom suggests that you withdraw on average 4% adjusted for inflation. Now comes a paper co-authored by William Sharpe, the winner of the 1990 Nobel Prize in Economics, challenging the conventional wisdom.
    …
    According to Sharpe, who is also the founder of Financial Engines, the typical 4% rule recommends that a retiree annually spend a fixed, real amount equal to 4% of his initial wealth, and rebalance the remainder of his money in a 60%-40% mix of stocks and bonds throughout a 30-year retirement period.

    What’s more, he shows the price paid for funding what he calls “unspent surpluses and the overpayments made to purchase its spending policy.” According to Sharpe, a typical rule allocates 10%-20% of a retiree’s initial wealth to surpluses and an additional 2%-4% to overpayments.
    …
    The only problem with what academia knows to be right and what’s practical in the field — even by Sharpe’s own admission — is this: “Many practical issues remain to be addressed before advisers can hope to create individualized retirement financial plans that maximize expected utility for investors with diverse circumstances, other sources of income, and preferences,” Sharpe wrote in his paper.
    …
    Meanwhile, Stephen P. Utkus, a principal with the Vanguard Center for Retirement Research, agrees that the 4% rule is flawed. But he also notes, as did Sharpe, that there’s no practical mechanism to replace it with and that further research is required.

    I think this is exactly right. The proper personal financial actions in this case are not easy. The 4% rule is far from perfect but it does give a general idea that is a decent quick snapshot. But you can’t rely on such a quick, overly simplified method. At the same time there are simple ideas that do work, such as saving money for retirement is necessary. The majority of people continue to fail to take the most basis steps to save money each year for retirement.

    Related: Spending Guidelines in Retirement – How Much Will I Need to Save for Retirement? – Bogle on the Retirement Crisis

  • Consumer Debt Needs to Decline Much More

    Economic data don’t point to boom times just yet

    American households are trying to reduce debt to stabilize finances. But they are doing so slowly, with total household debt at 94 percent of gross domestic product in the fourth quarter down just slightly from 96 percent when the recession began in late 2007.
    …
    By contrast, that ratio of household debt to economic output was 70 percent in 2000. To get back to that level, Americans would need to pay down $3.4 trillion in debt

    And it isn’t like the 2000 level was one of great consumer discipline. The economy needs to improve in several ways to be approaching a state that could be called a healthy economy. The 2 biggest, in my mind are 1) decreasing debt (consumer and government) and 2) increasing jobs. My next most important would probably be increasing the number of “good” jobs. Many other data points are important, such as: decreasing income inequality; increasing the age at retirement (because of all the systemic problems caused by extremely long retirements financed not by savings but taxes on existing workers); low inflation (luckily that is continuing to look good); value added economic activity (real GDP); decrease in the cost of the health care system as a % of GDP; decrease in financial leverage; economic strength worldwide (economic weakness of Japan, Europe… can severely hamper economic success in the USA). I do not see a bubble hyped economy as a healthy economy – even if lots of measures look good.

    Related: Americans are Drowning in Debt – Dollar Decline Due to Government Debt or Total Debt? – Financial Illiteracy Credit Trap – Consumer Debt Down Over $100 Billion So Far in 2009 (Nov 2009)

  • Will The Savings Rate Fall Back Again

    Welcome to the False Recovery by Eric Janszen

    Because of the way the government measures household savings, the increase doesn’t signify more money in people’s wallets; instead, it suggests that consumers are paying off their mounting debt during a period of reduced borrowing. That’s no harbinger of growth.

    Companies planning for sudden and relatively near-term growth should reshape their strategies to make the best of economic flatness.

    He makes a decent point for companies, but the he flips back and forth between the need to save more (because we are buried in debt) and the need to spend more (because we need to grow the economy right now). And while I wouldn’t stake my life on it I wouldn’t be surprised that we have a strong economic rebound (it is also perfectly conceivable we have a next to no growth or even fall into a recession). But it seems to me the return to bubble thinking and spending beyond our means is making a strong comeback.

    The money is not going under mattresses or into bank accounts, from where it will emerge one day to jump-start the economy. It’s actually subsidizing the previous boom, which was built on debt and the presumption that assets would always cover that debt.

    Another ok, point but we have hardly paying off anything of the previous living beyond our means. It would take decades at this rate.

    Banks can loosen lending policies to allow people to borrow and spend again—but for that to solve anything, consumers must be extremely judicious in how they take on and use their debt. It’s more likely that consumer debt levels will rise again as individuals stretch themselves to afford what they want. Alas, this will drive the reported savings rate back down. By the end of 2010, I expect it to dip below 3%. Then, any drop in asset values will set off the debt trap. We’ll again see a rising savings rate and tightened lending, followed by loosened lending and a declining savings rate. The recovery will become a series of starts and stops: promising progress, periods of retreat.

    So the problem is the saving are not actually resulting in increased ability to spend (first point above) – which is bad he says, because it means their won’t be more spending (because people won’t have the ability to spend). Then he says when banks lend the consumers money they will spend and the saving rate will go down (which is bad – though he doesn’t seem to really want more savings (because that means business won’t get increased sales).

    The conventional wisdom likes to point out the long term problem of low savings rate but then quickly point out we need more spending or the economy will slow. Yes, when you have an economy that is living beyond its means if you want to address the long term consequences of that it means you have to live within your means. It isn’t tricky. We need to save more. If that means the economy is slower compared to when we lived beyond our means that is what it takes. The alternative is just to live beyond your means for longer and dig yourself deeper into debt.
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  • Bill Gross Warns Bond Investors

    Bill Gross Warning May Catch Bond Investors Off-Guard

    Pacific Investment Management Co.’s Gross, manager of the world’s biggest bond fund, said yesterday in an interview with Tom Keene on Bloomberg Radio that “bonds have seen their best days.” Pimco, which announced in December that it would offer stock funds, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher- yielding corporate securities.

    The prospect of a strengthening U.S. economy and rising interest rates makes an “argument to not own as many” bonds, Gross said in the interview.
    …
    Treasuries have rallied for almost three decades, pushing the yield on the 10-year Treasury note from a high of 15.8 percent in September 1981 to 3.89 percent as of yesterday. The yield reached a record low of 2.03 percent in December 2008 during the height of the credit crunch.
    Excess borrowing in nations including the U.S., U.K. and Japan will eventually lead to inflation as governments sell record amounts of debt to finance surging deficits, Gross said.

    “People have been making money on fixed income for so long, people assume it’s going to continue when mathematically, it cannot,” said Eigen, whose fund is the third-best selling bond fund this year, according to Morningstar. “When people finally start to lose money in fixed-income, they won’t hesitate to pull money out very soon,” he said.

    John Hancock Funds President and Chief Executive Officer Keith Hartstein said retail investors are already late in reversing their rush into bond funds, repeating the perennial mistake of looking to past performance to make current allocation decisions.

    I agree bonds don’t look to be an appealing investment. They still may be a smart way to diversify your portfolio. I am investing some of my retirement plan in inflation adjusted bonds and continue to purchase them. My portfolio is already significantly under-weighted in bonds. I would not be buying them if it were not just to provide a small increasing of my bond holdings.

    Related: Municipal Bonds, After Tax Return – 10 Stocks for Income Investors – Bond Yields Show Dramatic Increase in Investor Confidence – Investors Sell TIPS as They Foresee Tame Inflation

  • In the USA 43% Have Less Than $10,000 in Retirement Savings

    There are several personal finance basics that everyone must account for. Retirement requires the most planning and accumulating the largest amount of money. Luckily if you plan ahead you have a long time for compounding to work in your favor. Unfortunately most people continue to fail to make even the most minimal efforts to save for retirement: 43% have less than $10k for retirement

    The percentage of workers who said they have less than $10,000 in savings grew to 43% in 2010, from 39% in 2009, according to the Employee Benefit Research Institute’s annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

    Fewer workers report that they and/or their spouse have saved for retirement (69%, down from 75% in 2009 and 72% in 2008. Moreover, fewer workers say that they and/or their spouse are currently saving for retirement (60%, down from 65 percent in 2009).

    27% say they have less than $1,000 in savings (up from 20% in 2009).

    46% report they and/or their spouse have tried to calculate how much money they will need to have saved for a comfortable retirement by the time they retire.

    What is a very rough estimate of what you need? Well obviously factors like a pension, social security payments, age at retirement, home ownership, health insurance, marital status… make a huge difference in the total amount needed. But something in the neighborhood of 15-25 times your desired retirement income is in the ballpark of what most experts recommend. So if you want $50,000 in income you need $750,000 – $1,250,000. Obviously that is difficult to save over a short period of time. The key to saving for retirement is a consistent, long term saving program.

    Related: Retirement Savings Survey Results (2007) – How Much Will I Need to Save for Retirement? – Personal Finance Basics: Long-term Care Insurance

  • Where to Invest for Yield Today

    Yields are staying amazingly low today. Due to the credit crisis the federal reserve is shifting hundreds of billions of dollars from savers to bankers to allow banks to make up for losses they experienced (both in losses on bad loans and huge cash payments made to hundreds of executives over more than a decade). For that reason (and others) yields are extremely low now which is a great burden on those that saved and counted on reasonable investment yield.

    Don’t be fooled by apologist for those causing the credit crisis that try and excuse their behavior and act as those paying back the bailout payments means they paid back the favors they were given. They have received much more from the policies of the federal reserve that has taken hundreds of billions of dollars from savers and given it to bankers. It has the same effect as a direct tax on savers being paid to bankers.

    What is an investor/saver to do? James Jubak provides some excellent advice.

    How to maximize what your cash pays even when nothing is paying much of anything now

    A three month Treasury bill pays just 0.12%. A two-year note pays just 0.79%. Inflation may not be very high at an annual rate of 2.6% for headline inflation (and 1.6% minus volatile energy and food prices) but it’s enough to eat up all the interest from those investments and more. (TIPS, Treasury Inflation-Protected Securities will protect you from inflation but the yields are really low (1.43% for a 10-year TIPS at recent auction) and they only protect you from inflation and not rising interest rates. I-Bonds, a savings bond that pays an interest rate that combines a fixed component, currently 0.3%, with an inflation-adjusted variable rate, current 3.06%, offer a higher yield but since the variable rate is pegged to inflation and not interest rates, the yield on these bonds won’t necessarily go up if interest rates do. You also have to hold for at least 12 months. (After that and until you’ve held for 5 years you lose the last 3-months of interest when you sell.)

    You could lock your money up for decades and get 4.56% in a 30-year Treasury bond but 30 years is forever. And besides interest rates have to go up from today’s lows and that means bond prices will be coming down, probably fast enough to eat up all the interest that bond pays and more.
    …
    Not if you remember that interest rates are going up in most of the world (except maybe Europe and Japan) quite dramatically over the next 12 months. A year from now, perhaps sooner, you’ll be able to get yields swell north of anything you can find now.

    That pretty much means that you’re guaranteed to lose money two ways by locking it up for the long term now.
    …
    For the short term you need to put your cash into something that’s as safe as possible but that offers you as much income as possible—and that doesn’t lock up your money for very long.

    My choice dividend paying stocks—if they pay a high dividend, are extremely liquid, and are battle tested.

    Whether you agree with his suggestions in the article is up to you. But even if you don’t he provides a very good overview of the options and risks that you have to navigate now as an investor seeking investments that provide a decent yield. I agree with him that interest rates seem likely to rise, making bonds an investment I largely avoid now myself.

    Related: posts on financial literacy – Jubak Picks 10 Stocks for Income Investors – S&P 500 Dividend Yield Tops Bond Yield: First Time Since 1958 – Bond Yields Show Dramatic Increase in Investor Confidence

  • Building an Emergency Fund

    Many people find personal financial planing boring. Building a cash safety net is an important part of your personal finances even though it isn’t exciting. I have written previously the very simple idea that you can just not buy what you can’t pay for. If you can’t pay for it this month, don’t buy it.

    But that leaves out one thing. Even if you do have the cash you should be building up a cash reserve before buying luxuries. The typical advice is to build up 6 months of expenses in cash (rent or mortgage, food bills, utilities, health care, etc.). Now actually building up to that level can take awhile and forgoing all non-mandatory expenses until you have that saved is not usually reasonable. But as part of your personal finances building up an cash reserve is important (even if it is boring). And I believe you really should aim at a higher level – say building to 1 year.

    A significant portion of downward spirals in personal finances are started when people have emergency expenses and have to borrow that money (since they don’t have cash reserves). And even worse when they start racking up huge fees for late payments, increased interest rates on outstanding debt, health care expenses if they fail to keep health care insurance…

    If you are over say 26 and don’t have a cash reserve yet saving for it should be part of your monthly budget. How quickly you build that up is a personal decision but I would say a 2% of the target amount (so if you are aiming for a cash reserve of $20,000 then $400/month). If you have next to nothing saved now start aiming at 6 months. As you get 3 months saved up start aiming at 9 months. As you get 6 months saved up start aiming at 1 year. And you have to also be saving for other needs – you shouldn’t raid your emergency fund savings for other things (a new car, a vacation…). This takes real discipline but it is much easier than the challenges our ancestors had to face of billions of people face financially today. So yes it is not easy, but really those that feel sorry for themselves need to realize they shouldn’t expect that they are so special the world owns them financial riches with little effort.

    Doing something is better than nothing so do what you can (even if it is less than 2% of you target). But realize that is one of the weaknesses in your personal finances and try to fix that as soon as possible.

    Very important personal financial allocations for you to put first include: current needs (food, car payment, rent/mortgage, utilities…), insurance, creating a cash reserve, retirement savings, saving for future purchases. Then there are luxuries and treats, such as: eating out, vacations, cable TV… Many people put current needs, luxuries and treats fist and then say they don’t have the ability to do what is responsible (check how rich you are – before making such claims yourself).

    Related: How to Protect Your Financial Health – Save Some of Each Raise – Buying Stuff to Feel Powerful – Consumer Debt Down Over $100 Billion So Far in 2009 – posts on basic personal finance matters