A Primer on Retirement Saving (Part 5 of 5)

In Part 1 of this series, hopefully I convinced you of how important it is to save for retirement.  In Part 2, I talked about the different options that exist for retirement savings.  In Part 3, I discussed how to efficiently prioritize the options that exist for your retirement savings.  In Part 4, I discussed how and where you go to sign up for your 401K, 403B and IRA.  In this final installment, Part 5 of this series, I discuss good investment options for your IRAs, 401Ks and 403Bs.

1)    Determine the Appropriate Asset Allocation for Your Age and Risk Tolerance 
Diversification is a powerful investment concept.  It refers to saving your investments in different baskets.  Diversification requires you to place your money in different investments with returns that are not completely moving in the same direction at the same times.  When some of your investments are up, others will be down. To decrease your chances of getting clobbered at the same time, you must put your money in different investments such as stocks, bonds and cash.  You can further diversify your investments by investing in domestic as well as international markets.  The process of how you spread your money around and diversify is called “asset allocation”.  The wise approach is to have more risk (equities) in your younger years and as you move into retirement move the majority of your money into less risky assets (bonds and cash). There are many different ways to allocate your assets for retirement, but below I outline one possibility. 

Age:  Less than 40 years

Allocation:  100 % in stocks.  Of this, 40% invested in large cap-growth funds, 25% in small-cap growth funds, 25% in large-cap value funds, and 10% in international.

Age:  40 – 50 years

Allocation:  80 % in stocks and 20% in bonds.  Of the stocks portion, 40% invested in large-cap growth funds, 25% small-cap growth funds, 25% large-cap value funds, and 10% in international.

Age:  51 – 55 years

Allocation:  70% in stocks and 30% in bonds.  Of the stocks portion, 40% invested in large-cap growth funds, 25% small-cap growth funds, 25% in large cap value funds, and 10% in international.

Age:  55 – 60 years

Allocation:  50% in stocks and 50% in bonds.  Of the bonds portion, 40% invested in large-cap growth funds, 10% small-cap growth funds, 40% in large cap value funds, and 10% international.

Age:  60 – 65 years

Allocation:  Reduce stocks by 5% per year and increase bonds by 5% per year so that at retirement you have 25% in equities and 75% in fixed income.  Of the equity portion, 40% invested in large-cap growth funds, 10% small-cap growth funds, 40% in large-cap value funds and 10% international.

2)    Choose High Quality/Low Cost Funds
The second factor to take into account when you are choosing the mutual funds in your accounts is cost.   Typically the lowest cost funds that one can buy are index funds.  An index fund is a fund that merely tracks a specific financial market.  For example an S&P 500 index fund just copies the movement of large cap stocks.  A Russell 2000 index is used to track small cap companies.  Index funds do not have managers making decisions about what to invest in so they are less expensive.  They also tend to outperform actively managed, more expensive funds.  So if these are an option within your plan, take advantage of them to carry out your asset allocation strategy.   

If actively managed funds are your only option, invest in them but be wary of expenses associated with the fund. Actively managed funds have expense ratios and loads that eat into your returns.  Minimize these costs as much as possible!

3)    Rebalance Your Portfolio Annually
The great thing about investing for retirement is that once you are set up you really don’t have to do much.  Just once a year look at your portfolio and make sure your investments still match up with the asset allocation you want.  Because your investments grow at different rates, this can throw off your asset allocation.  Make sure you rebalance it every year!

I hope you have enjoyed this 5 part series on Investing for Retirement.  Please contact me with any questions or clarifications!

Please contact Dollars & Sense Education to bring our “Financial Health 101” seminar to your company or organization! 

Dollars & Sense Education – Raising Your Financial IQ!
215 – 499 – 3834 

Why Your AMEX Is Dinging Your Credit Score

As I teach in my Financial Health 101 Seminar, one determinant of your credit score is how much of your credit you are using or your “credit utilization”.  The simplest example would be you only have one credit account, a Visa with a $10,000 maximum, and you carry a $1,000 balance.  This would be 10% credit utilization.  Pretty straightforward, right? Not always.  Many people carry charge cards that do not have a pre-set spending limit and these can hurt your credit score.

During a break at a recent seminar at a law firm in Manhattan, an attorney asked me how his no limit American Express would affect his credit score.  Because his American Express has no pre-defined spending limit, how did American Express report his credit usage to the credit bureaus?  The answer is, charge cards report the highest amount ever charged monthly on the card to the credit bureaus as your credit limit.  This typically results in a high credit utilization, effectively lowering your credit score.  For example, if the most you have ever charged on your AMEX in a month is $2,000 and you typically carry a $1,000 balance this is a 50% credit utilization.  Compare this to your 10% utilization on the VISA with a $10,000 limit.

Moral of the story, charge cards are detrimental to your credit score!

Can We Trust The Bank To Know What an IRA IS?

I got a frantic telephone from a good friend this afternoon.  She and her husband had just left the bank in a failed attempt to open a joint Roth IRA.  She said, I need you to calm me down. 

The short versoin of the story is they entered the bank, sat down with a representative and explained to her that they would like to invest $8,000 in a Roth IRA.  She said the representative seemed puzzled and fumbled around for awhile telling them that she was having technical difficulties with the computer.  My friend started to suspect that something was amiss.  After about a half hour of fumbling, the representative pulls out a brochure with investment options that range from 3 months to 8 years.

 My friend asks, aren’t IRAs supposed to be long term investments?  The representative tells her, no after the IRA matures you will either put it in a similar investment or another investment.  The woman was selling her a CD!!! 

The analogy I used to my friend was, imagine you walk into Best Buy and ask to see the laptop choices and instead, the associate show you the flat screen tvs.   That is basically what happened to my friends at their bank.  Not only would my friends have bought the wrong product, they would have suffered tax consequences as well.

It is completely baffling to me that a bank representative does not know the difference between a CD and an IRA.  Just another proof source that we need to be armed with as much personal finance knowledge as possible so that we are not misled by “experts” to make costly mistakes.