Sunday, January 19

Week 133 - Here’s a “Safety First” Retirement Plan With Expenses Under $7/yr

Situation: We all know that investing for retirement is problematic, uncertain, and expensive. We’ve all thought about what it would feel like to depend solely on Social Security for retirement income. And, we all know that the current level of government financing for Social Security is unsustainable due to the relentless growth in the numbers and longevity of retirees, combined with ever fewer workers per retiree contributing to fund the program. Anyone over 50 who doesn’t understand the effect this could have on her sunset years hasn’t been paying attention the past few decades.

Mission: Design a personal retirement plan to supplement Social Security and workplace retirement plans. The plan must minimize transaction costs, bankruptcy risk, and inflation/deflation risk to whatever extent possible.

Here’s how we suggest setting up such a plan. Stocks grow in value during inflation while bonds grow in value during recession. You’ll need both. If you dollar-average by investing small amounts of money 50:50 into bonds and stocks on a regular basis, your retirement savings will grow regardless of inflation and deflation. 

As an aside, Central Banks (such as our Federal Reserve) have so many ways to disguise and allay deflation that we only know they are doing so when interest rates fall to absurdly low levels. Pundits call it “printing money” but the technical term is Financial Repression (see Week 79). We’re in a period of financial repression now, meaning that money is so cheap for corporations and banks to obtain that prices for stocks and real estate rise faster than earnings or rents can justify. The Fed’s idea is to “jump start” the economy enough--by encouraging private investment with free money--that it will grow on its own. Once victory is declared and financial repression ends, the favor is returned. Stock and real estate prices will then slow their growth while earnings and rents catch up. Since free money will no longer be available, interest rates will rise to normal or temporarily inflated levels. When will financial repression end? Judging from precedent, that won’t be soon. To prevent deflation following World War II, it lasted from 1947 until 1980.

To eliminate the risk of bankruptcy, purchases for this plan are confined to stocks and bonds that have a AAA credit rating from Standard and Poor’s. When we checked the candidates, we found that 4 companies qualified, along with 10-yr US Treasury Notes. The stocks are Microsoft (MSFT), Johnson & Johnson (JNJ), Exxon Mobil (XOM), and Automatic Data Processing (ADP). Treasuries can be obtained at zero cost at treasurydirect; we recommend inflation-protected 10-yr Notes which are sold in January and July of each year. XOM and JNJ can be obtained at no cost through computershare, although you’ll be charged $1 for each JNJ purchase if you use automatic withdrawals from your checking account. (There is no charge for separate point-and-click JNJ purchases through computershare.) Purchases of MSFT shares through Microsoft’s online transfer agent are expensive, and there’s no online transfer agent for ADP. So, it is best to use a low-cost online broker for those. For example, you can use TD Ameritrade or Capital One. The cost per trade at those sites is currently $6.95.

JNJ is a hedge stock (see Week 126), so you don’t need to back up those purchases with an equal purchase of 10-yr Treasury Notes. That leaves 3 stocks (MSFT, XOM, ADP) to be balanced with Treasuries (or listed as 7 items in all, see the Table). For example, you could decide to invest $4,200/yr. That is, $600/yr per line item which is the same as $300/half, $150/qtr, or $50/mo. For XOM, automatic withdrawals from your checking account in the amount of $50/mo is both free and convenient using computershare. For zero-cost investments in JNJ and 10-yr Treasuries, go online every 6 months to invest $300 in JNJ at computershare and $900 in 10-yr Treasuries at treasurydirect. For lowest-cost investing ($6.95/yr) in ADP and MSFT, make alternate-year purchases of $1200 each through an online broker like Capital One or TD Ameritrade. In summary, T-Notes, JNJ and XOM are free; MSFT and ADP are purchased on alternate years for $6.95. Your out-of-pocket cost is $6.95/yr. This plan carries considerably less risk than VWINX, the safest low-cost balanced mutual fund (see Columns D and J in the Table), even though 10-yr returns are almost identical (Column F). Note: metrics in red indicate underperformance relative to our benchmark, the Vanguard Balanced Index Fund (VBINX).

When you retire, change from automatic reinvestment of quarterly dividends to having the dividends mailed to you. For Treasuries, there is no automatic reinvestment of interest. You receive interest payments twice a year deposited into your checking account, and return of the principal amount ($900) after 10 yrs. When you retire, stop making any “rollover” purchases, which you may have scheduled for T-Notes that are maturing every 6 months. Then you simply receive the principal amount of maturing T-Notes in your checking account. Reinvest T-Note interest payments in inflation-protected Savings Bonds at treasurydirect and hold those for at least 5 yrs before cashing them in, at which time you’ll be taxed for the accumulated interest payments.

Bottom Line: It’s always a good idea to have a personal retirement savings account, even if you already contribute the maximum allowed amount to a company-sponsored retirement plan. Why? Because corporations can change or discontinue their employee retirement plans. And, the Federal government will no doubt be changing long-standing Social Security policies for future retirees. You can have a tax-advantaged aspect of your personal, point-and-click retirement savings account simply by having your accountant declare it to be an IRA, as long as the annual limit for contributions isn’t exceeded. 

To avoid gambling with your personal retirement savings plan, you’ll need to include investments with AAA credit ratings. That way you don’t have to worry about bankruptcy. And make sure you hedge against the risk of recession because anytime that stocks go down, T-Notes go up. Finally, don’t spend any money on transaction costs that you don’t absolutely have to spend.

Risk Rating: 3

Full Disclosure: I regularly buy 10-yr T-Notes, MSFT, JNJ, and XOM.

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