Situation: You’re bombarded with advice about how to save for retirement. But unless you’re already rich, the details are simple. Dollar-cost average 60% of your contribution into a stock index fund and 40% into a short or intermediate-term bond index fund. If you know you’ll never be in “the upper middle class”, opt for the short-term bond index fund. But maybe you have a workplace retirement plan, which makes saving for retirement a little more complicated. Either way, you’ll want to contribute the maximum amount each year to your IRA, which is currently $5500/yr until you reach age 50; then it’s $6500/yr.
Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV.
Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.
Execution: see Table.
Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.
Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label Roth IRA. Show all posts
Showing posts with label Roth IRA. Show all posts
Sunday, September 16
Sunday, December 30
Week 78 - Master List Update (Q1 2013)
Situation: The time has come to provide sober guidance about saving for retirement. For most people, mutual funds are the best route to take and we’ve listed our 5 favorites in the accompanying Table. We remind you that you should not have more than 20% of your assets in a single fund, or 5% in a single stock. As noted in our Week 3 blog (see Goldilocks Allocations), it is also important to balance your stock investments 1:1 with bonds. Our 5 mutual funds do that when you have 20% of your retirement savings in each.
Whew! Now for the fun stuff, which is to generate a list of stock picks that meet our investment criteria. Previously, we’ve agonized over company fundamentals like efficiency (ROIC), long-term debt, and having enough free cash flow to pay for dividend increases (FCF/div). In this blog, we’re going to let you do that for yourself by using red warning flags in the 3 right hand columns of the Table (courtesy of data from the WSJ). This way, you’ll see the entire “universe of data” we analyze, starting with the 199 companies at the Buyupside website called Dividend Achievers. Those companies have had 10 or more consecutive years of dividend increases. We’ve added Occidental Petroleum (OXY) which will qualify come January first.
Next, we eliminate any company with a dividend yield less than the 15-yr moving average for the S&P 500 Index (1.8%). Then we eliminate any company that doesn’t have an S&P stock rating of A/M or better AND an S&P bond rating of BBB+ or better.
The remaining 49 companies can be split into two groups, those whose stocks lost less than 65% as much as the S&P 500 Index during the Lehman Panic AND had a 5-yr Beta of less than 0.65. Those 19 companies are less risky that the others, and make up the first group at the top of the Table. The 30 remaining companies are in the second group, and the 5 mutual funds (mentioned above) compose the third group.
Which of the top 19 stocks are particularly attractive to the risk-averse investor? We think those are the ones that pay a higher dividend than most others AND grow that dividend faster. I use a 3:7:10:50 standard for finding those good "income" stocks. By this I mean there is at least a 3% dividend yield, at least a 7% dividend growth rate, at least a 10% ROIC (5% for a regulated utility), and less than 50% capitalization from bonds. Six in the top 19 meet that standard: JNJ, ABT, PEP, PG, NEE, MCD. However, we eliminate Abbott Labs (ABT) because it is breaking up into two companies, so we’re down to 5.
Those readers who are over 55 and have little in the way of retirement savings should pay attention to these 5 reliable income producing stocks. We’ll aggregate the data from those, to augment our guidance for late-stage investors (see Retirement on a Shoestring Week 14 & Week 15). These 5 stocks are so bond-like that you needn't bother hedging them with an equal investment in bonds or bond funds. But you do need to “dollar-average” equally into all 5 DRIPs. We'll call this group "Stand Alone Stocks" and put their aggregate data at the bottom of the Table for comparison with aggregate data for the 5 mutual funds we mentioned.
Bottom Line: Recent academic studies show that returns from less risky (more bond-like) stocks are as great as returns from more risky stocks. Read this recent analysis by Mark Hulbert to open your eyes to the importance of holding such stocks in your portfolio.
Risk Rating: 4.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Whew! Now for the fun stuff, which is to generate a list of stock picks that meet our investment criteria. Previously, we’ve agonized over company fundamentals like efficiency (ROIC), long-term debt, and having enough free cash flow to pay for dividend increases (FCF/div). In this blog, we’re going to let you do that for yourself by using red warning flags in the 3 right hand columns of the Table (courtesy of data from the WSJ). This way, you’ll see the entire “universe of data” we analyze, starting with the 199 companies at the Buyupside website called Dividend Achievers. Those companies have had 10 or more consecutive years of dividend increases. We’ve added Occidental Petroleum (OXY) which will qualify come January first.
Next, we eliminate any company with a dividend yield less than the 15-yr moving average for the S&P 500 Index (1.8%). Then we eliminate any company that doesn’t have an S&P stock rating of A/M or better AND an S&P bond rating of BBB+ or better.
The remaining 49 companies can be split into two groups, those whose stocks lost less than 65% as much as the S&P 500 Index during the Lehman Panic AND had a 5-yr Beta of less than 0.65. Those 19 companies are less risky that the others, and make up the first group at the top of the Table. The 30 remaining companies are in the second group, and the 5 mutual funds (mentioned above) compose the third group.
Which of the top 19 stocks are particularly attractive to the risk-averse investor? We think those are the ones that pay a higher dividend than most others AND grow that dividend faster. I use a 3:7:10:50 standard for finding those good "income" stocks. By this I mean there is at least a 3% dividend yield, at least a 7% dividend growth rate, at least a 10% ROIC (5% for a regulated utility), and less than 50% capitalization from bonds. Six in the top 19 meet that standard: JNJ, ABT, PEP, PG, NEE, MCD. However, we eliminate Abbott Labs (ABT) because it is breaking up into two companies, so we’re down to 5.
Those readers who are over 55 and have little in the way of retirement savings should pay attention to these 5 reliable income producing stocks. We’ll aggregate the data from those, to augment our guidance for late-stage investors (see Retirement on a Shoestring Week 14 & Week 15). These 5 stocks are so bond-like that you needn't bother hedging them with an equal investment in bonds or bond funds. But you do need to “dollar-average” equally into all 5 DRIPs. We'll call this group "Stand Alone Stocks" and put their aggregate data at the bottom of the Table for comparison with aggregate data for the 5 mutual funds we mentioned.
Bottom Line: Recent academic studies show that returns from less risky (more bond-like) stocks are as great as returns from more risky stocks. Read this recent analysis by Mark Hulbert to open your eyes to the importance of holding such stocks in your portfolio.
Risk Rating: 4.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 15
Week 41 - Personal Savings Modules
Situation: Many of us who have retirement benefits through our jobs tend to not fully fund our plan, thus not receiving the full tax advantage of the retirement benefits, even though it would reduce our annual tax bill. And it gets worse! Some of us do fully fund our workplace retirement plan and that can STILL leave us with too few dollars for our sunset years. Is there a solution? Yes,we need to mimic our neighbors who don’t have a workplace retirement plan but instead use IRAs (including Roth IRAs), and US Savings Bonds to build Personal Savings Modules (PSMs).
This week’s blog assumes that IRAs are understood and in common use by our readers. In reality, fewer than 25% of job holders contribute to an IRA; fewer than half of those contributors are not paying the full amount allowed by law per year (for a related story click here). Since you’re reading this blog, we will assume you want a fully funded IRA at $5000/yr (in DRIPs) balanced with $5000/yr in Savings Bonds (which have the same tax benefits as an IRA). And let’s face another tough fact--chances are that if you are in the early stages of your career, you don’t have enough income to do this. This means we need a way to decide how much of your income can safely be siphoned off into retirement savings as you age.
We recommend investing 5% of gross income at age 25 and increasing this up to 20% by age 70. In other words, every 3 years add another 1% to your savings plan. If you’re 25 years old and making $20,000/yr, set aside $1000/yr (5%). By age 50, 14% needs to be diverted to your workplace retirement plan and PSMs. By retirement age (71), those savings plus Social Security will need to replace at least 70% of the income you were receiving through work.
The simplest and cheapest way to start a PSM is to go online and set up automatic monthly withdrawals from your bank account. A balanced mutual fund would be just the ticket--a “starter home” for your savings! The problem we immediately encounter is that all of them have irritatingly high costs, take on too much risk, or don’t invest enough in bonds. The only balanced fund that roughly mimics what we call a “Goldilocks Allocation” (see Week 3) is the Vanguard Wellesley Fund (VWINX). It has a very low expense ratio (0.25%) and no fees or commissions but it requires an initial purchase of $3000. For many of us, that is a stretch. The second best choice for a hybrid investment is to buy stock in a regulated public utility. ITR’s Master List (Week 39) suggests two: NextEra Energy (NEE) and Wisconsin Electric (WEC). Investing in either of these companies would give you a DRIP with rock bottom costs that can be managed by you from the website. For tax purposes, that DRIP then needs to be designated as part of your IRA.
For a follow-on PSM, we suggest that you stretch beyond relying on a single-asset and balance it with regular purchases of a Lifeboat Stock DRIP balanced by purchases of US Savings Bonds. The accompanying Table lists all the Lifeboat Stocks that are also on our Master List (Week 39). For your Savings Bonds, we recommend choosing traditional (EESB) Savings Bonds because those are guaranteed to pay at least 3.5%/yr if you hold them for 20 yrs. (Prior to that anniversary date, each EESB purchased pays approximately the same interest as a 5-yr Treasury Note that was purchased on that same date.) As an example, I constructed a PSM using a JNJ DRIP started 12 yrs ago using $100/mo, and balanced it with EESBs I started purchasing 20 yrs ago (~$50/mo). By 4/2/2012, the $12,200 paid into EESBs had grown to $27,068.44 (a 6.3%/yr increase) and the $14,200 that went to JNJ had grown to $18,867.80 (a 4.2%/yr increase). That’s an increase of 4.6%/yr for both together, which beats inflation by 2.1%/yr.
Should you be one of the lucky few who has a workplace retirement plan, contribute as much as you are allowed by law but avoid the exciting/expensive choices: emerging market mutual funds, high-yield bond funds or small capitalization stock funds. If you’re offered hedge funds, don’t take the bait (for fun, do a Google search on the terms “Warren Buffett” & “Hedge Funds”). Stick with “plain vanilla” choices: large-capitalization US stock funds and intermediate-term investment-grade bond funds. If your company wants you to stuff your retirement savings plan full of its own stock, don’t go there! No company is immune from bankruptcy. For example, Johns-Manville and over 10,000 other companies were bankrupted in the 1980s by asbestos-related lawsuits. Even though many of the lawsuits were later declared to be criminally fraudulent, by that time the companies were gone. Enron is another example with 6000 of its employees putting all of their retirement savings into its stock and losing every penny when the company collapsed. If you do choose to purchase company stock, limit those holdings to 5% of your total assets--the same limit you would place on any other single company’s stock.
What kind of assets, overall, are good for your retirement savings? To ride out the last market crash defensively with Lifeboat Stocks (see attached Table) as measured by the drop in each of those stocks between 10/1/07 and 4/1/09, the best DRIPs to have were: WEC, JNJ, ABT, BDX, WMT, HRL, and MKC. Those went down less than 20% (vs. 46% for VFINX, the Vanguard S&P 500 Index Fund). Wal*Mart stock even went up 19% (Table). Did your portfolio have any of those stocks going into the crash? Mine had only two (JNJ and MKC). A market crash of that magnitude usually means one thing: Investors are afraid of deflation. There are only two types of assets that do well then: 10-30 yr US Treasury Notes & Bonds, and stock in companies that sell food very cheap: McDonald’s and Wal*Mart. Unless you had those assets and some of the more resilient Lifeboat Stocks noted above, your portfolio probably took a beating. Even the most resilient balanced fund (VWINX) went down 24% over that 18-month period.
Bottom Line: If a crash occurred one month after you retired, would your portfolio be able to ride it out relatively unscathed??
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
This week’s blog assumes that IRAs are understood and in common use by our readers. In reality, fewer than 25% of job holders contribute to an IRA; fewer than half of those contributors are not paying the full amount allowed by law per year (for a related story click here). Since you’re reading this blog, we will assume you want a fully funded IRA at $5000/yr (in DRIPs) balanced with $5000/yr in Savings Bonds (which have the same tax benefits as an IRA). And let’s face another tough fact--chances are that if you are in the early stages of your career, you don’t have enough income to do this. This means we need a way to decide how much of your income can safely be siphoned off into retirement savings as you age.
We recommend investing 5% of gross income at age 25 and increasing this up to 20% by age 70. In other words, every 3 years add another 1% to your savings plan. If you’re 25 years old and making $20,000/yr, set aside $1000/yr (5%). By age 50, 14% needs to be diverted to your workplace retirement plan and PSMs. By retirement age (71), those savings plus Social Security will need to replace at least 70% of the income you were receiving through work.
The simplest and cheapest way to start a PSM is to go online and set up automatic monthly withdrawals from your bank account. A balanced mutual fund would be just the ticket--a “starter home” for your savings! The problem we immediately encounter is that all of them have irritatingly high costs, take on too much risk, or don’t invest enough in bonds. The only balanced fund that roughly mimics what we call a “Goldilocks Allocation” (see Week 3) is the Vanguard Wellesley Fund (VWINX). It has a very low expense ratio (0.25%) and no fees or commissions but it requires an initial purchase of $3000. For many of us, that is a stretch. The second best choice for a hybrid investment is to buy stock in a regulated public utility. ITR’s Master List (Week 39) suggests two: NextEra Energy (NEE) and Wisconsin Electric (WEC). Investing in either of these companies would give you a DRIP with rock bottom costs that can be managed by you from the website. For tax purposes, that DRIP then needs to be designated as part of your IRA.
For a follow-on PSM, we suggest that you stretch beyond relying on a single-asset and balance it with regular purchases of a Lifeboat Stock DRIP balanced by purchases of US Savings Bonds. The accompanying Table lists all the Lifeboat Stocks that are also on our Master List (Week 39). For your Savings Bonds, we recommend choosing traditional (EESB) Savings Bonds because those are guaranteed to pay at least 3.5%/yr if you hold them for 20 yrs. (Prior to that anniversary date, each EESB purchased pays approximately the same interest as a 5-yr Treasury Note that was purchased on that same date.) As an example, I constructed a PSM using a JNJ DRIP started 12 yrs ago using $100/mo, and balanced it with EESBs I started purchasing 20 yrs ago (~$50/mo). By 4/2/2012, the $12,200 paid into EESBs had grown to $27,068.44 (a 6.3%/yr increase) and the $14,200 that went to JNJ had grown to $18,867.80 (a 4.2%/yr increase). That’s an increase of 4.6%/yr for both together, which beats inflation by 2.1%/yr.
Should you be one of the lucky few who has a workplace retirement plan, contribute as much as you are allowed by law but avoid the exciting/expensive choices: emerging market mutual funds, high-yield bond funds or small capitalization stock funds. If you’re offered hedge funds, don’t take the bait (for fun, do a Google search on the terms “Warren Buffett” & “Hedge Funds”). Stick with “plain vanilla” choices: large-capitalization US stock funds and intermediate-term investment-grade bond funds. If your company wants you to stuff your retirement savings plan full of its own stock, don’t go there! No company is immune from bankruptcy. For example, Johns-Manville and over 10,000 other companies were bankrupted in the 1980s by asbestos-related lawsuits. Even though many of the lawsuits were later declared to be criminally fraudulent, by that time the companies were gone. Enron is another example with 6000 of its employees putting all of their retirement savings into its stock and losing every penny when the company collapsed. If you do choose to purchase company stock, limit those holdings to 5% of your total assets--the same limit you would place on any other single company’s stock.
What kind of assets, overall, are good for your retirement savings? To ride out the last market crash defensively with Lifeboat Stocks (see attached Table) as measured by the drop in each of those stocks between 10/1/07 and 4/1/09, the best DRIPs to have were: WEC, JNJ, ABT, BDX, WMT, HRL, and MKC. Those went down less than 20% (vs. 46% for VFINX, the Vanguard S&P 500 Index Fund). Wal*Mart stock even went up 19% (Table). Did your portfolio have any of those stocks going into the crash? Mine had only two (JNJ and MKC). A market crash of that magnitude usually means one thing: Investors are afraid of deflation. There are only two types of assets that do well then: 10-30 yr US Treasury Notes & Bonds, and stock in companies that sell food very cheap: McDonald’s and Wal*Mart. Unless you had those assets and some of the more resilient Lifeboat Stocks noted above, your portfolio probably took a beating. Even the most resilient balanced fund (VWINX) went down 24% over that 18-month period.
Bottom Line: If a crash occurred one month after you retired, would your portfolio be able to ride it out relatively unscathed??
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 15
Week 28 - Net-Net-Net investing
Situation: Our ITR blog is focused on long-term savings that can be used for retirement, and without paying any more in fees than is necessary to achieve that goal. That means explaining how a newby investor can set aside 15% of income for at least 15 yrs and maintain a risk level that is less than 1 in 20 of losing her principal investment. In prior blogs, we discussed minimizing fees & commissions by using point-and-click investing but there are also fungible costs that cannot be avoided, namely, inflation and taxes. According to Webster's Collegiate Dictionary (11th Ed), fungible means “that one part or quantity may be replaced by another equal part or quantity in the satisfaction of an obligation”. In other words, someone else defines those obligations and those definitions can change over time. Here at ITR, we’ve factored the cost of inflation into the calculations presented in our spreadsheets but we haven’t said much about how to minimize it. And the only mention of taxes we’ve made has been to encourage you to use Roth IRAs, employer’s 401(a) & 403(b) plans, and savings bonds. Again, we haven’t said much about how to reduce the taxes due on your investment winnings.
Goal: a) Construct an investment portfolio consistent with our Goldilocks Allocation (Week 3) distribution while attempting to achieve a positive return net of fees, inflation, and taxes.
b) Assume that our investor is 50 yrs old with a gross taxable income of $96,000/yr.
c) Assume that our investor will spend $1200/mo on combined retirement and Rainy Day savings over a 15 yr period, resulting in an out-of-pocket expenditure of $216,000.
For the portfolio: We recommend allocating $6000/yr to a Roth IRA composed of dividend re-investment plans (DRIPs) in 5 stocks, $6000/yr to ISBs (inflation-protected savings bonds) and EESBs (standard savings bonds that guarantee a 3.5% return if held for 20 years), $1200/yr to a NextEra Energy (NEE) DRIP, and $1200/yr to a Rainy Day Fund composed 50:50 of a Johnson & Johnson (JNJ) DRIP and ISBs. Central to our strategy is to pay no taxes on the 50% of retirement savings in stocks (by assigning those DRIPs to a Roth IRA), and to delay paying federal taxes on the 50% in savings in bonds until retirement (there are no state or local taxes due on savings bonds). A Rainy Day Fund by definition needs to be accessible, so the stock portion of the fund will be taxable.
An investment of $1200/yr in stock of the regulated utility (NEE) is a “hybrid investment”, i.e., it doesn’t need to be hedged in the usual way with an equally weighted purchase of investment-grade bonds--because both the debt and the return on investment are guaranteed by a state government. These unusual features also help to offset the tax bill; you’re rewarded with a higher dividend (~4%) that helps pay taxes on those dividends. (Capital gains will be taxed upon sale but that isn’t until after you’ve retired and are in a lower tax bracket.)
Recommended Roth IRA stocks: We support the plan of investing 2/3rds of our sample portfolio’s monies in DRIPs chosen from among Core Holding stocks (e.g. XOM, CVX, PX, NSC, UTX). Care needs to be taken to include at least one company with heavy exposure to international markets (e.g. MCD, KO, MMM, BHP). The remaining 1/3rd of investment monies should be used to purchase DRIPs from among the Lifeboat Stocks (e.g. MKC, PG, ABT, JNJ, BDX, WMT, WAG).
In our virtual retirement portfolio, we’ll assign $125/mo to each of 4 Roth IRA DRIPs (XOM, KO, WMT, UTX), $250/mo to EESBs, $250/mo to ISBs, and $100/mo to the NEE DRIP (for a total of $1100 per month). For the Rainy Day Fund, we’ll assign $50/mo to ISBs and $50/mo to a JNJ DRIP. That brings the total monthly investment to $1200.
In a future blog, we’ll see how this portfolio holds up going forward and retrospectively. Will it provide a positive return after tallying and subtracting all expenses (fees & commissions, inflation, and taxes)? We’ll also look at the small number of academic studies that have been done on Net-Net-Net investing. Be warned--these studies are perhaps a little discouraging because any positive return is considered worthy of recognition! That’s mainly because it’s hard to spend less than 2%/yr on fees & commissions unless you “go it alone”. Another reason is that savings bonds are excluded from most asset allocation models because purchases are limited ($5000/yr for both ISBs and EESBs).
Bottom Line: Have you figured out what your “take home pay” is in real terms? It’s one thing to crow about winnings but quite another to add up all the losses incurred from such things as commissions & fees, taxes, and inflation. After those 3 expenses have been backed out of total annual gains, what remains is called “Net-Net-Net investing” and this is what real investing for profit is all about.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Goal: a) Construct an investment portfolio consistent with our Goldilocks Allocation (Week 3) distribution while attempting to achieve a positive return net of fees, inflation, and taxes.
b) Assume that our investor is 50 yrs old with a gross taxable income of $96,000/yr.
c) Assume that our investor will spend $1200/mo on combined retirement and Rainy Day savings over a 15 yr period, resulting in an out-of-pocket expenditure of $216,000.
For the portfolio: We recommend allocating $6000/yr to a Roth IRA composed of dividend re-investment plans (DRIPs) in 5 stocks, $6000/yr to ISBs (inflation-protected savings bonds) and EESBs (standard savings bonds that guarantee a 3.5% return if held for 20 years), $1200/yr to a NextEra Energy (NEE) DRIP, and $1200/yr to a Rainy Day Fund composed 50:50 of a Johnson & Johnson (JNJ) DRIP and ISBs. Central to our strategy is to pay no taxes on the 50% of retirement savings in stocks (by assigning those DRIPs to a Roth IRA), and to delay paying federal taxes on the 50% in savings in bonds until retirement (there are no state or local taxes due on savings bonds). A Rainy Day Fund by definition needs to be accessible, so the stock portion of the fund will be taxable.
An investment of $1200/yr in stock of the regulated utility (NEE) is a “hybrid investment”, i.e., it doesn’t need to be hedged in the usual way with an equally weighted purchase of investment-grade bonds--because both the debt and the return on investment are guaranteed by a state government. These unusual features also help to offset the tax bill; you’re rewarded with a higher dividend (~4%) that helps pay taxes on those dividends. (Capital gains will be taxed upon sale but that isn’t until after you’ve retired and are in a lower tax bracket.)
Recommended Roth IRA stocks: We support the plan of investing 2/3rds of our sample portfolio’s monies in DRIPs chosen from among Core Holding stocks (e.g. XOM, CVX, PX, NSC, UTX). Care needs to be taken to include at least one company with heavy exposure to international markets (e.g. MCD, KO, MMM, BHP). The remaining 1/3rd of investment monies should be used to purchase DRIPs from among the Lifeboat Stocks (e.g. MKC, PG, ABT, JNJ, BDX, WMT, WAG).
In our virtual retirement portfolio, we’ll assign $125/mo to each of 4 Roth IRA DRIPs (XOM, KO, WMT, UTX), $250/mo to EESBs, $250/mo to ISBs, and $100/mo to the NEE DRIP (for a total of $1100 per month). For the Rainy Day Fund, we’ll assign $50/mo to ISBs and $50/mo to a JNJ DRIP. That brings the total monthly investment to $1200.
In a future blog, we’ll see how this portfolio holds up going forward and retrospectively. Will it provide a positive return after tallying and subtracting all expenses (fees & commissions, inflation, and taxes)? We’ll also look at the small number of academic studies that have been done on Net-Net-Net investing. Be warned--these studies are perhaps a little discouraging because any positive return is considered worthy of recognition! That’s mainly because it’s hard to spend less than 2%/yr on fees & commissions unless you “go it alone”. Another reason is that savings bonds are excluded from most asset allocation models because purchases are limited ($5000/yr for both ISBs and EESBs).
Bottom Line: Have you figured out what your “take home pay” is in real terms? It’s one thing to crow about winnings but quite another to add up all the losses incurred from such things as commissions & fees, taxes, and inflation. After those 3 expenses have been backed out of total annual gains, what remains is called “Net-Net-Net investing” and this is what real investing for profit is all about.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 13
Week 19 - Really Simple Savings
Situation: Many investors want to spend about as much time planning for retirement as they would spend planning for a vacation. They can’t afford to be “dollared to death” by fees and commissions. At the same time, they need a balanced portfolio which means that the “balancer” (or hedge) will increase in value when the stock market tanks.
Goal: Find a straightforward way for a 50 yr old investor to begin to seriously plan for retirement at age 65, without an exorbitant outlay of time or money to set up the portfolio.
Most probably this type of investor doesn’t follow the markets or invest each month in separate DRIP accounts. And we would also guess that $500/mo is the most our investor will commit to setting aside. These caveats leave a Roth IRA composed of no-load mutual funds as the best investment option. The reason is because a Roth IRA is unique among retirement investment options due to its tax-free status with no taxes levied on withdrawals ever, even for the unused money that goes to heirs.
Half the monthly money allotted by our investor ($250/mo) should be used to purchase shares of an S&P 500 Index Fund. The other half should be invested in an intermediate-term US Treasury Fund (i.e., a fund that essentially buys 10-yr Treasury Notes and holds those to collect interest until the principal is returned). Why these two particular choices? Related to stock purchases, this type of investor cannot assume the risk of under-performing compared to the market. Related to bond purchases (i.e., the hedge), this type of investor needs to be in the safest possible market. That would be the asset that the entire world wants to own when financial markets collapse: US Treasury Notes.
Most probably this type of investor doesn’t follow the markets or invest each month in separate DRIP accounts. And we would also guess that $500/mo is the most our investor will commit to setting aside. These caveats leave a Roth IRA composed of no-load mutual funds as the best investment option. The reason is because a Roth IRA is unique among retirement investment options due to its tax-free status with no taxes levied on withdrawals ever, even for the unused money that goes to heirs.
Half the monthly money allotted by our investor ($250/mo) should be used to purchase shares of an S&P 500 Index Fund. The other half should be invested in an intermediate-term US Treasury Fund (i.e., a fund that essentially buys 10-yr Treasury Notes and holds those to collect interest until the principal is returned). Why these two particular choices? Related to stock purchases, this type of investor cannot assume the risk of under-performing compared to the market. Related to bond purchases (i.e., the hedge), this type of investor needs to be in the safest possible market. That would be the asset that the entire world wants to own when financial markets collapse: US Treasury Notes.
All “no-load” mutual fund companies offer both S&P 500 and T-Note funds with low expense ratios. We’ll use T Rowe Price funds to calculate outcomes for monthly purchases made from 2/3/97 through 11/1/11 (14.8 yrs). PREIX is the S&P 500 Index Fund and PRTIX is the intermediate-term US Treasury Fund. Investing $250/mo in each would result in $52,975 in the stock fund (total return = 2.2%/yr) and $69,853 in the bond fund (total return = 5.3%/yr) for a compound annual growth rate (CAGR) of 3.9%/yr (1.5%/yr after inflation). Our investor’s out-of-pocket investment over this time would have been $86,500 and total value would be $122,828. The S&P 500 fund paid out $472 in dividends over the past 6 months and the T-Note fund paid $783 in interest (i.e., the two together currently yield a little over 2%). Since the beginning of good record-keeping practices (1926), the CAGR after inflation is 2.3% for T-Notes and 6.7% for the S&P 500 Index without factoring in expenses. The rule-of-thumb for advising investors (as to what they can expect for planning purposes) is 2% and 4%, respectively. So a 50:50 combination is expected to yield 3%/yr. However, that overlooks the fact that the CAGR drifts upward when leverage (or borrowed money) is used to fuel investments. The opposite occurs with de-leveraging. In other words, when governments/companies/individuals borrow money to make improvements in their investments, those investments grow in value at a more rapid rate than if revenues alone are used to make improvements. When that borrowed money is returned to the lender, revenues are depleted so severely that little is left for “growth” (just google “Italy” for a timely example).
Saving for retirement doesn’t have to be complicated but it does have to be sincere. If you religiously set aside $500/mo beginning at age 50, you’ll have around $125,000 at age 65 in the example above. After retiring, you can spend the $200+/mo of dividends and interest and leave the principal intact. That would allow your spending power to keep up with inflation and your heirs will be titillated. Or you can cash out the funds and purchase an annuity that pays ~$800/mo but won’t keep up with inflation or leave anything for heirs.
Bottom Line: This 50:50 Stock/Bond example is a benchmark for a simple, safe and cheap Roth IRA plan. Interestingly, the initial $500 invested on 2/3/97 held its value throughout two bear markets, though it did fall back to parity ($500) at the depths of the last bear market on 3/9/09. We’ll use that feature to help gauge the safety of other Roth IRA strategies.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 16
Week 15 - Retirement on a Shoestring: The Rainy Day Fund
Situation: A middle-income worker reaches age 50 without a pension, 401(k), or 403(b) plan. She’ll need to put aside the maximum amount allowed ($6,000/yr) into a Roth IRA. In addition, it would be smart to start a “Rainy Day Fund” (~$1,200/yr) to protect the Roth IRA from being depleted in the event of illness or unemployment.
Goal: Determine how much money would be in the proposed Roth IRA and Rainy Day Funds (started at age 50) upon approaching a retirement age of 65, using the lowest expenses and least risky investments.
Everyone needs to have a Rainy Day Fund as the first line of defense for economic well being. It needs to be readily available without paying significant penalty fees for early withdrawal (aside from taxes due). Such a fund should contain enough to pay 6 months of basic expenses. Most people use a savings account but here at ITR we advocate for something a little more remunerative. Consider a fund that balances stocks and bonds 50:50.
On the bond side, the Inflation-protected Savings Bond (ISB) is hard to beat. It is the benchmark for “net net net investing” (i.e., total return after expenses, inflation, and taxes). An ISB has no up-front expenses (and you know from our prior blogs that is a big point). To purchase yours, go to Treasurydirect and set up electronic withdrawals from your bank account. ISBs pay a fixed rate of interest but also add principal in direct proportion to inflation. There are no taxes on an ISB until you cash it in, typically at a time of minimal tax liability, ideally, after retirement. Invest at least $50/mo until you have enough ISBs to cover 3 months of living expenses. A small fee is assessed if you withdrawal your money prior to 5 years after purchase (you pay 3 months worth of interest income).
To cover the remaining 3 months of expenses, invest at least $50/mo in a Lifeboat Stock with a low beta and high dividend. Abbott Laboratories (ABT) meets those requirements and setting up your DRIP using Computershare is user-friendly. There are no fees for an automatic investment plan of as little as $10/mo. [There is one significant inconvenience: the initial shares need to be purchased through a stock broker and transferred electronically to Abbott Laboratories for registration in your name.] Other DRIPs to consider include Johnson & Johnson (JNJ), Procter & Gamble (PG), and Wal*Mart (WMT). Most of those DRIPs charge ~$1/mo but do not require you to register shares through a stock broker.
Once you have your Rainy Day Fund and Roth IRA (review Week 14) on autopilot, you will breathe a little easier. Now you can take an active interest in the rest of your retirement preparations, namely, paying off your obligations which for most people is a mortgage. This will leave you well positioned for starting a reverse mortgage at age 65. We also recommend taking an active approach to keeping your job skills tuned up by taking one evening class per semester at a local community college. This allows the maximum level of flexibility for remaining competitive in your current job, or finding a new job if that (unhappy) situation should arise.
We have attached a Spreadsheet summarizing the investment options mentioned for establishing a Roth IRA (Week 14) and a Rainy Day Fund. ISBs did not become available until 1999, so the history of transactions is shorter than what we’ve used in other examples. But if the total return for that shortened period (3.33%/yr) were to be applied for the same 14.7 yr period as our other examples, the total amount invested would be $8,850 (same as for ABT) and the ending value would be $11,587 instead of the $9,241 listed in the spreadsheet. That would bring the total ending value for the Rainy Day Fund to $24,966 after 14.7 yrs (total return = 4.16%/yr). Since the ending value for the proposed Roth IRA is $155,955, the total savings for retirement equals $180,921. That money could be used, for example, to purchase a fixed annuity paying over $1,000/mo beginning at age 65 in today’s dollars. Alternatively, you could just cease paying the $7,200/yr and draw the annual dividend and interest income from that $180,921 (i.e., $6,107/yr, or $509/mo). That payout would continue to grow ~4%/yr faster than inflation while leaving the principal untouched. Taxes would only be due on expenditures from the Rainy Day Fund. Social Security would likely add >$2,000/mo to your retirement income, which amount is partly taxable but also keeps up with inflation.
Let’s face it, $2,600+ a month doesn’t go very far even if it is protected from inflation and taxes. This is why setting up a reverse mortgage and continuing to work will become important options to have available for fine-tuning your retirement income.
Bottom Line: Retirement is perilous. Plan ahead. It’s later than you think.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Goal: Determine how much money would be in the proposed Roth IRA and Rainy Day Funds (started at age 50) upon approaching a retirement age of 65, using the lowest expenses and least risky investments.
Everyone needs to have a Rainy Day Fund as the first line of defense for economic well being. It needs to be readily available without paying significant penalty fees for early withdrawal (aside from taxes due). Such a fund should contain enough to pay 6 months of basic expenses. Most people use a savings account but here at ITR we advocate for something a little more remunerative. Consider a fund that balances stocks and bonds 50:50.
On the bond side, the Inflation-protected Savings Bond (ISB) is hard to beat. It is the benchmark for “net net net investing” (i.e., total return after expenses, inflation, and taxes). An ISB has no up-front expenses (and you know from our prior blogs that is a big point). To purchase yours, go to Treasurydirect and set up electronic withdrawals from your bank account. ISBs pay a fixed rate of interest but also add principal in direct proportion to inflation. There are no taxes on an ISB until you cash it in, typically at a time of minimal tax liability, ideally, after retirement. Invest at least $50/mo until you have enough ISBs to cover 3 months of living expenses. A small fee is assessed if you withdrawal your money prior to 5 years after purchase (you pay 3 months worth of interest income).
To cover the remaining 3 months of expenses, invest at least $50/mo in a Lifeboat Stock with a low beta and high dividend. Abbott Laboratories (ABT) meets those requirements and setting up your DRIP using Computershare is user-friendly. There are no fees for an automatic investment plan of as little as $10/mo. [There is one significant inconvenience: the initial shares need to be purchased through a stock broker and transferred electronically to Abbott Laboratories for registration in your name.] Other DRIPs to consider include Johnson & Johnson (JNJ), Procter & Gamble (PG), and Wal*Mart (WMT). Most of those DRIPs charge ~$1/mo but do not require you to register shares through a stock broker.
Once you have your Rainy Day Fund and Roth IRA (review Week 14) on autopilot, you will breathe a little easier. Now you can take an active interest in the rest of your retirement preparations, namely, paying off your obligations which for most people is a mortgage. This will leave you well positioned for starting a reverse mortgage at age 65. We also recommend taking an active approach to keeping your job skills tuned up by taking one evening class per semester at a local community college. This allows the maximum level of flexibility for remaining competitive in your current job, or finding a new job if that (unhappy) situation should arise.
We have attached a Spreadsheet summarizing the investment options mentioned for establishing a Roth IRA (Week 14) and a Rainy Day Fund. ISBs did not become available until 1999, so the history of transactions is shorter than what we’ve used in other examples. But if the total return for that shortened period (3.33%/yr) were to be applied for the same 14.7 yr period as our other examples, the total amount invested would be $8,850 (same as for ABT) and the ending value would be $11,587 instead of the $9,241 listed in the spreadsheet. That would bring the total ending value for the Rainy Day Fund to $24,966 after 14.7 yrs (total return = 4.16%/yr). Since the ending value for the proposed Roth IRA is $155,955, the total savings for retirement equals $180,921. That money could be used, for example, to purchase a fixed annuity paying over $1,000/mo beginning at age 65 in today’s dollars. Alternatively, you could just cease paying the $7,200/yr and draw the annual dividend and interest income from that $180,921 (i.e., $6,107/yr, or $509/mo). That payout would continue to grow ~4%/yr faster than inflation while leaving the principal untouched. Taxes would only be due on expenditures from the Rainy Day Fund. Social Security would likely add >$2,000/mo to your retirement income, which amount is partly taxable but also keeps up with inflation.
Let’s face it, $2,600+ a month doesn’t go very far even if it is protected from inflation and taxes. This is why setting up a reverse mortgage and continuing to work will become important options to have available for fine-tuning your retirement income.
Bottom Line: Retirement is perilous. Plan ahead. It’s later than you think.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 9
Week 14 - Retirement on a Shoestring: The Roth IRA
Situation: Many people spend their careers working at jobs that offer slim retirement benefits. Consider this: a year of retirement will cost you about as much as a year of private college. Unlike a child’s college expenses, retirement doesn’t end after 4 years! Many people are now in a situation with big problems looming on the retirement horizon. Those with little money set aside for retirement have only 4 ways to supplement Social Security income (excluding extortion):
1) convert home equity to a reverse mortgage,
2) raid their “Rainy Day Fund”,
3) remain employed for more years,
4) set up a Roth IRA.
Goal: Explain to a 50 yr old how to start a retirement plan based around a Roth IRA.
Okay, you’ve reached the age of 50 with little by way of retirement savings, and you know you need a sound retirement plan. One thing that Congress got right was to provide middle income workers with a special kind of IRA, called a Roth IRA. With standard IRAs, you receive an annual tax deduction for monies invested but as those monies are spent in retirement you will pay taxes as with ordinary income. A Roth IRA, however, uses monies that are already taxed so that the monies spent in retirement are tax-free. From an accountant’s point of view, a Roth IRA is a bonanza! It shows the lengths to which Congress will go to entice people to save for retirement.
We want a benchmark to use for the IRA recommendations we’ll be making and have picked the Vanguard Wellesley Fund (VWINX), a bond-centric no-load balanced fund that channels our Goldilocks Allocation to some degree. VWINX had been perking along for several decades without much attention but now investors are taking notice. The reason is that during the recession it posted one of the best records among balanced funds. VWINX has done rather well: investing $200 a month since 2/1/97 would have yielded $57,497 by 10/7/11 for a total return of 5.67%/yr (pretty sweet). This compares favorably to the same investment in the S&P 500 Index, SPY, which would have yielded $40,349 for a total return of 1.69%/yr (not so sweet). The top-performing balanced fund during the recession (MDLOX, the Blackrock Global Allocation Fund that we highlighted in Week 13) yielded $61,233 for a total return of 6.31%/yr (also rocking the house). During that 14.7 year period, inflation averaged 2.5%/yr according to the BLS.
After age 50, you can pay $6,000/yr into a Roth IRA. We set up a $3,000 allocation to stocks and picked a model portfolio of 3 “low beta” DRIPs. These were chosen because they carry no investment costs if purchased through Computershare. [Please note: the same purchases could be made using Sharebuilder at an accumulated expense of $144/yr, which cuts 0.5%/yr off your total return.] We selected XOM ($75/mo), BDX ($75/mo), and NEE ($100/mo). Over 14.7 yrs (ending 10/7/11), the $75/mo invested in XOM ($13,275) returned $24,592 for a total return of 7%/yr; the $75/mo invested in BDX ($13,275) returned $25,286 for a total return of 7.28%/yr; and the $100/mo invested in NEE ($17,700) returned $34,860 for a total return of 7.61%/yr. All together, $250/mo was invested in 3 DRIPs ($44,250) and returned $84,738 for a total return of 7.33%/yr. This beats SPY by more than 5.6% a yr. It also beats inflation by more than 4.8%/yr. Other DRIP combinations can be selected and may show even better results.
For the bond side of our demonstration Roth IRA ($3,000), we’ll track $250/mo invested in the diversified T. Rowe Price investment-grade fund, PRCIX. For the 14.7 years ending 10/7/11, that monthly investment would have totaled $44250 and yielded $69,984 for a total return of 5.38%/yr. It is a no-load fund, so we have now constructed a no-load Roth IRA fund balanced 50:50 between stocks and bonds. Our fund is composed of 4 assets and carries no investment costs: XOM, BDX, NEE, and PRCIX. Our benchmark balanced fund (VWINX) is also a no-load fund. In addition, we’ll show what would happen if you invested $6000/yr in MDLOX (Blackrock Global Allocation A), which is also a balanced fund but carries a front-end load of 5.25%. That is, you’d be paying $26.25 in fees with each month’s $500 investment. [While there are other share classes that have a lower initial cost, this is compensated by a higher expense ratio. For long-term investors, the A class shares (MDLOX) are the most economical.] Our model balanced fund composed of 3 stocks and one bond fund yielded $154,633 over 14.7 years on a total investment of $88,500, for a total return of 6.42%/yr. This compares well to the 6.31% total return for MDLOX and 5.67% for VWINX. So our key point is that even the best-performing managed stock fund can be bested by regular purchase and dividend reinvestment using DRIPs in combination with a diversified bond fund, without paying any upfront fees or commissions.
In next week’s blog, we’ll provide a spreadsheet of our proposed Roth IRA and also outline a proposed “Rainy Day Fund”. We’ll include appropriate benchmarks and update the spreadsheet periodically, and model additional DRIP choices from the Master List. In an upcoming edition of “The Incubator”, we’ll discuss the process for incorporating DRIPs into a Roth IRA plan.
Bottom Line: If you’re earning less than $100,000/yr and don’t have a pension plan or 401(k) plan through your employer, it’s time to start a Roth IRA. Don’t delay - the pain only increases!!
<click here to continue to Week 15>
1) convert home equity to a reverse mortgage,
2) raid their “Rainy Day Fund”,
3) remain employed for more years,
4) set up a Roth IRA.
Goal: Explain to a 50 yr old how to start a retirement plan based around a Roth IRA.
Okay, you’ve reached the age of 50 with little by way of retirement savings, and you know you need a sound retirement plan. One thing that Congress got right was to provide middle income workers with a special kind of IRA, called a Roth IRA. With standard IRAs, you receive an annual tax deduction for monies invested but as those monies are spent in retirement you will pay taxes as with ordinary income. A Roth IRA, however, uses monies that are already taxed so that the monies spent in retirement are tax-free. From an accountant’s point of view, a Roth IRA is a bonanza! It shows the lengths to which Congress will go to entice people to save for retirement.
We want a benchmark to use for the IRA recommendations we’ll be making and have picked the Vanguard Wellesley Fund (VWINX), a bond-centric no-load balanced fund that channels our Goldilocks Allocation to some degree. VWINX had been perking along for several decades without much attention but now investors are taking notice. The reason is that during the recession it posted one of the best records among balanced funds. VWINX has done rather well: investing $200 a month since 2/1/97 would have yielded $57,497 by 10/7/11 for a total return of 5.67%/yr (pretty sweet). This compares favorably to the same investment in the S&P 500 Index, SPY, which would have yielded $40,349 for a total return of 1.69%/yr (not so sweet). The top-performing balanced fund during the recession (MDLOX, the Blackrock Global Allocation Fund that we highlighted in Week 13) yielded $61,233 for a total return of 6.31%/yr (also rocking the house). During that 14.7 year period, inflation averaged 2.5%/yr according to the BLS.
After age 50, you can pay $6,000/yr into a Roth IRA. We set up a $3,000 allocation to stocks and picked a model portfolio of 3 “low beta” DRIPs. These were chosen because they carry no investment costs if purchased through Computershare. [Please note: the same purchases could be made using Sharebuilder at an accumulated expense of $144/yr, which cuts 0.5%/yr off your total return.] We selected XOM ($75/mo), BDX ($75/mo), and NEE ($100/mo). Over 14.7 yrs (ending 10/7/11), the $75/mo invested in XOM ($13,275) returned $24,592 for a total return of 7%/yr; the $75/mo invested in BDX ($13,275) returned $25,286 for a total return of 7.28%/yr; and the $100/mo invested in NEE ($17,700) returned $34,860 for a total return of 7.61%/yr. All together, $250/mo was invested in 3 DRIPs ($44,250) and returned $84,738 for a total return of 7.33%/yr. This beats SPY by more than 5.6% a yr. It also beats inflation by more than 4.8%/yr. Other DRIP combinations can be selected and may show even better results.
For the bond side of our demonstration Roth IRA ($3,000), we’ll track $250/mo invested in the diversified T. Rowe Price investment-grade fund, PRCIX. For the 14.7 years ending 10/7/11, that monthly investment would have totaled $44250 and yielded $69,984 for a total return of 5.38%/yr. It is a no-load fund, so we have now constructed a no-load Roth IRA fund balanced 50:50 between stocks and bonds. Our fund is composed of 4 assets and carries no investment costs: XOM, BDX, NEE, and PRCIX. Our benchmark balanced fund (VWINX) is also a no-load fund. In addition, we’ll show what would happen if you invested $6000/yr in MDLOX (Blackrock Global Allocation A), which is also a balanced fund but carries a front-end load of 5.25%. That is, you’d be paying $26.25 in fees with each month’s $500 investment. [While there are other share classes that have a lower initial cost, this is compensated by a higher expense ratio. For long-term investors, the A class shares (MDLOX) are the most economical.] Our model balanced fund composed of 3 stocks and one bond fund yielded $154,633 over 14.7 years on a total investment of $88,500, for a total return of 6.42%/yr. This compares well to the 6.31% total return for MDLOX and 5.67% for VWINX. So our key point is that even the best-performing managed stock fund can be bested by regular purchase and dividend reinvestment using DRIPs in combination with a diversified bond fund, without paying any upfront fees or commissions.
In next week’s blog, we’ll provide a spreadsheet of our proposed Roth IRA and also outline a proposed “Rainy Day Fund”. We’ll include appropriate benchmarks and update the spreadsheet periodically, and model additional DRIP choices from the Master List. In an upcoming edition of “The Incubator”, we’ll discuss the process for incorporating DRIPs into a Roth IRA plan.
Bottom Line: If you’re earning less than $100,000/yr and don’t have a pension plan or 401(k) plan through your employer, it’s time to start a Roth IRA. Don’t delay - the pain only increases!!
<click here to continue to Week 15>
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