Sunday, April 17

Week 250 - A Monthly Retirement Savings Plan With Automatic Online Additions

Situation: If you’re self-employed or work at a company that doesn’t sponsor a 401(k) or 403(b) retirement plan, you need to create your own. The “secret sauce” is payday deductions. Economists often say that the parts of your income you never see are the parts you stop thinking about. Pay stubs list those automatic withdrawals for taxes, social security, health insurance, and a tax-deferred retirement plan but you no longer care: You’re receiving “full benefits” which is why you took the job in the first place.

If you’re one of the 50% of US workers who doesn’t have a workplace retirement plan, you need to go to start an IRA funded with payday deductions. This can be done by visiting a bank, brokerage, credit union or by going online to a low-cost mutual fund site like Vanguard Group. You can also set up monthly automatic withdrawals from your checking account to invest in Dividend Re-Investment Plans (DRIPs). Your accountant will report to the IRS that those constitute your IRA. That works best if you backup those stock investments with bonds by using one of the US Treasury’s zero-cost IRA-like plans (Savings Bonds and MyRA), which have no transaction costs. At their website, you’ll see an option for automatic monthly withdrawals from your checking account.

Mission: Set up a spreadsheet that illustrates an automatic online retirement savings plan with monthly additions for each item.

Execution: If your net worth (excluding home & mortgage) is less than $1 Million, you needn’t bother with picking stocks and bonds. Just go to the Vanguard Group website and pick the Vanguard Wellesley Income Fund (VWINX at Line 25 in the Table), which is 45% stocks and 55% bonds. Make that your IRA and set up monthly withdrawals from your checking account. If you’re self-employed as an “S Corporation”, the IRS provides special tax-deferred retirement options geared to your situation. 

If you choose to pick your own dividend-paying stocks and back those with Treasuries, read on: 
I. Bonds
You’ll need to start by assigning 25% to 75% of your savings to US Treasury issues, with the percentage depending on your view of the economic climate. The only automatic monthly withdrawal plan offered by the US Treasury are for Savings Bonds and MyRA. Inflation-adjusted Savings Bonds (“I Bonds”) are your best choice if you might want to cash in some for emergencies. The total return on Savings Bonds is approximately the same as for 10-yr Treasury Notes that have been renewed every 10 yrs, once you consider the tax benefit from owning Savings Bonds. The biannual interest paid on Savings Bonds is accrued and cannot be taxed until after you cash the bonds, whereas, tax is due every year on the the biannual interest you receive from Treasury Notes.
II. Stocks
The remaining 25% to 75% of your retirement savings plan needs to reflect growth in the economy. There are 10 S&P industries in the economy and you’ll probably gain the most benefit if you pick a stock for each. No one can predict which industry will take the lead in a future growth spurt, and each of the 10 has taken the lead at some point in the past. To set up automatic online investments each month, you’ll need to pick stocks that pay a dividend. The two largest online DRIP vendors are Computershare and Shareowneronline.

Administration: This week’s Table is a spreadsheet for stocks I have picked (one for each S&P industry), combined with a 50% commitment to 10-yr Treasury Notes that serve as proxies for Savings Bonds. In the Table, we assume that $100/mo is invested in each stock online and $1000/mo is invested in Savings Bonds online. The total investment is $24,000/yr and the transaction costs come to $164/yr (see Column Z in the Table). The Expense Ratio (164/24000) is 0.68% for the first year. If the economy keeps growing, that $164/yr will become an increasingly smaller fraction of the asset value.

Bottom Line: Polls have shown that “planning for retirement” is the biggest financial worry Americans have after “out of control spending.” Partly this is because 50% of Americans work where there is no retirement plan. The secret to success from stashing away ~15% of your gross income in a 401(k) or 403(b) plan is that you never see the money unless you look at the paystub. If you want success from setting up a retirement plan without those 401(k) or 403(b) tools, you need to mimic them. Have the money disappear automatically from your paycheck or checking account. Sending that money to a “conservative allotment, low-cost balanced mutual fund” like The Vanguard Balanced Index Fund (VBINX in the Table) is a good way to begin solving the problem with an IRA. If you are self-employed as an S Corporation, you can set aside the entire 15% or more of your income in a tax-advantaged retirement plan. You can also pick dividend-paying stocks for your IRA, plus Inflation-protected Savings Bonds and MyRAs that are tax-advantaged like an IRA.

Risk Rating: 4

Full Disclosure: I use the plan summarized in the Table.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. The Vanguard Wellesley Income Fund or VWINX. Total Returns in Column C date to 9/1/2000, a peak in the S&P 500 Index.

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