Saner Savings

Forbes has a recent article, Seven Steps to Saner Savings, that lays out the different ways an individual can save for retirement.

There's little question as to if one wants to save, it's a matter of in what account?

"Most investors ignore the asset-location issue. They fail to recognize the significant impact of placing the right assets in the right buckets," says John Nersesian of Nuveen Investments' Wealth Management Services. General advice: Use taxable accounts to hold individual stocks (these present better opportunities for loss harvesting) and index funds or exchange-traded index funds that don't throw off much taxable income. Put your assets with the highest growth potential in a Roth. Taxable bonds and REITs belong in a pretax 401(k) or IRA; the income they generate is taxed at ordinary rates anyway, and this way the tax is deferred. Also good for your pretax 401(k) or IRA are assets that generate short-term gains, which are taxed at ordinary income rates--stocks you trade a lot and actively managed small-company or international funds.

Phew! The article breaks down each vehicle, from a 401k, to a Roth, to a taxable account (ie brokerage account such as Sharebuilder). It's one of the shortest guides I've seen, and pretty easy to digest.

Why Playing Lotto is NOT Saving & Other Retirement Reality Checks

Today I picked up some wine for the pot-luck party M & I are throwing tommorrow and out of habit I glanced at the lotto machine by the cashier. The jackpot wasn't above $200 million, so I wasn't tempted, but there is always a steady stream of people scribbling in their numbers. Lotto is obviously gambling, but it's also, in a warped sense, a form of saving and investing for many people. And that is the scary part.

The 2005 Retirement Confidence Survey cites 14 percent of Americans who are not saving a penny for retirement play the lottery at least once a week. Whoa. The current undulations of the Dow have better odds than one in a million. Face it, if you play lotto you are a disciplined investor, someone who removes a dollar or two from their wallet, like clockwork, with the hope that it will come back to them in a bar of gold. Kind of like Apple stock, or AT&T, or a company that makes solar panels. The obvious difference is that one involves suspension of reason, and the other does not. But the discipline is there, it just got hijacked by better marketing. Because the reality is that a lot of people who play lotto daily are working class and/or poor. Fidelity, Vanguard, Fortune magazine, and MarketWatch are not exactly targeting them for marketing and education on how to properly save and invest for retirement.

By being cut off from the world of investing, like NYC's bartenders and waitstaff, you tend to think that you can't save. What, you think some white collar cubicle jockey gets to decide what percentage of her paycheck goes to health insurance? What percentage towards her 401K in order for the matching investment to kick in? You think they want to take home a smaller paycheck? They're not necessarily better at saving, they just have the opportunity to have less choice in the matter.

My feeling is this, whether you're a hair above the poverty line buying lotto tickets every day or the Maître d' at Balthazar tipping $20 each free round of drinks at a friend's bar, disposable income is disposable income, and that's the part that you slice up for savings. You don't need to be wealthy to invest, you need to have disposable income and discipline. And guess what, mutual fund company T. Rowe Price will take as little as fifty bucks a month with no money down. You can read more of my it's easy-to-save-for-your-retirement tirade here.

So let's put it this way, $20 a month in lotto tickets for 30 years will get you jack $h*T, and $20 in an index fund returning 9% a year for that same period will get you $34,288. It's not enough to retire on, but this example, like playing lotto, is no retirement plan. It's just an illustration of what jack $h*t could look like instead of, you know, jack.

The Financial Planning Association is a professional group for financial planners, and they have a great list of stats that are a good wake up call. Here are some of my favorites-

"20 percent of Americans actually believe winning the lottery is their best shot at accumulating several hundred thousand dollars over their lifetimes."
- 2005 Consumer Federation of America and Financial Planning Association consumer survey

"[Americans] have the lowest personal savings rate since the Great Depression - in January 2006 it dropped to minus 0.7 percent."
- April 2006 Workforce Management

"A large percentage of American workers see that the U.S. retirement system is going through major changes, but many are not taking steps that are likely to leave them well-positioned for a comfortable retirement."
- 2007 17th annual Retirement Confidence Survey (RCS)

Creating wealth by saving a little at a time over a longer period of time is not the same as hitting jackpot, but it is the odds on favorite. If you like dreaming big, just dream that Steve Jobs is gonna keep on inventing computerized crack and buy his stock. And this part is important- like playing lotto, you don't need to be wealthy to have that discipline. It's getting close to New Year's resolution time. Time to max out your 2008 Roth IRA and steer yourself towards retirement and away from the lotto line.

photo by DogFromSPACEvia flikr

Why You Need To Start Saving NOW

I was talking with a friend this weekend about financial stuff. It started with a simple question, how do you save and pay off debt at the same time? A simple question begat a long ass answer and, many emails later, I think she is on her way to a monthly spending diary. Because the first answer to any question is, do you know how much you spend?

It's a good question, though. And I kind of think the answer is you can't afford not to save. In 2008 the max on your Roth IRA is five grand a year (again a warning to bartenders, waitresses, and other cash cow hustlers- you cannot contribute more than you earn, as in what's reported to the IRS). So I did a quick calculation and came up with the following.

If you were to start saving in January for your retirement, you're starting with zero balance, and you were to max out your Roth IRA contribution at $5,000 a year for 30 years, could you retire? Drumroll please... The answer is with $713,182 (assuming 8% annual returns). Great, you say. Not so fast. The same calculation, but with 3.1% inflation, and you get $264,353. What?!

Well, remember that time way back when and you took the subway with a token and it was a buck and a quarter? Or that time when you gave the movie theater a ten dollar bill and got change back? That is called inflation, the nasty fact of life that a dollar today is worth less tommorrow. The adjusted figure is what $700,182 is worth in today's dollars. $264,353. I know I've harped on this before. Blogger redundancy. But with oil near $100 a barrel, major banks and lenders on market welfare (aka the sub prime loan mess), and recession arguably on the radar, all of which means the smarty pants with MBAs are defecating bricks right about now. Since they're the ones running the economy, it might be prudent of us to to take care that our own finances are in order.

The first step to any financial plan is to track your spending and then make a budget. So my friend will submit her monthly budget, and I'll start posting on the practical side of how to pay off debt and start saving for your future.

A Mutual Fund for Hipsters

Reading Gothamist this morning and I choked on my coffee. Why, hello there Thrasher Fund, the GenX mutual fund. Excuse me while I roll my eyes back and gaze at my sockets. I am so going to the free 30 minute consultation.

Their GendeX Mutual Fund (GENDX) has a 1.00% management fee, a 2% redemption fee if shares sold within first 12 months, and a $100 minimum with $50 minimum automatic investment every month. Fine. What's not cool is the $2/month fee for accounts below $2,500. Holdings include Apple, Gucci, American Apparel, Uniqlo, and China Mobile. Hence, the fund's name.

Well, this was all very entertaining. Hipsters are probably the most middle class counter culture generation in recent history. They are so not falling for this.

Gay Seniors Act Up

Well, here's a different take on a retirement community. The LA Times has an interesting article, Room Under the Rainbow, on gay retirement communities mulling over the straight retirees moving in.

RainbowVision (damn that Dorothy) is a gay retirement community on the outskirts of Santa Fe. When they first opened it was promoted almost entirely within the gay community. Of course, housing discrimination laws in NM include sexual orientation, and the housing market slowdown has left many homes on the market. Some sellers have opened their doors to the straight community, swinging open the debate over a gay majority wide open.

It's an interesting dimlemma. Gay seniors overcame obstacles people of my generation never had to deal with. For most residents, it's a matter of safety. Their own. After a lifetime of living with homophobia, they simply want to retire without it. Of course, I'd prefer to retire in a city of 12 million in the heart of the West Village, but my retirement savings aren't quite up to speed...

Eating Pie

The better you bake those pie charts now, the better they'll be when you start gorging yourself on them later. If you are just starting out, and you want low maintenance retirement savings, it is my humble pie opinion that you look at a mutual fund that offers a target retirement fund.

A target retirement fund is a mutual fund that allocates a certain percentage of each share to different markets, adjusting the percentages as your target date of retirement nears. Each share addresses asset allocation, rebalancing, and fund selection for you. For example, the mutual fund company T. Rowe Price has a target retirement fund 2045. This assumes you are retiring within a few years of 2045. The Retirement 2045 fund currently has an asset allocation of 92.25% invested in stocks, the remainder in fixed income (ie various bonds and some cash). Your asset allocation will slowly shift to less stocks and more fixed income as you near (and pass) the year 2045. In contrast, the Retirement 2005 fund has an asset allocation of only 55.25% in stocks, the remainder in various bonds and some cash. Despite it being two years past the targeted retirement date of this fund, the slim majority is still invested in stocks. Today's life expectancy is 80, with a 45% chance that a 55 year old today will live past 90. The aggressiveness, and therefore risk, of today's retirement portfolio reflects these realities.

What exactly is asset allocation? It is basically what types of stocks and bonds you buy, according to how much risk you can/should take. Let's say you are medium risky; you are flat out broke and can handle the up and down ride of the price of Google, but you aren't about to bet the house on it. Let's say you are also 35 years old. So you're young, but no spring chicken. Asset allocation takes into account both risk tolerance and age. A significantly larger portion of your portfolio would be in stocks, because you gotta be in it to win it, maybe even dipping a toe or too in riskier sectors like technology. A smaller but necessary percentage would be in various fixed income assets, ie bonds, because the returns are more predictable and usually do not move in tandem with the stock market. Of course, as your age increases your risk tolerance decreases. Then your asset allocation woud move more money into the less risky bonds, and trim down the percentage of stock holdings. Asset allocation is used to fend off the ups and downs of the market with diversification. Basically, you don't put all your eggs in one basket, because if the basket breaks you're $hit out of luck.

Of course, fact is nobody can predict the future. I don't care what they say to your insomniatic ass on late night infomercials. And while the stock market is a closely studied beast with unpredictable twists and turns, it is asset allocation that forces you to buy low and sell high. "Buy low and sell high"- that famously prescient adage that nobody does when push comes to shove and the Dow just dropped its pants on live national tv. Let's say, hypothetically, that of the part of the pie that is in stocks, 50% is in the large US companies (large caps), 20% in middle sized US companies (mid caps), 15% in small US companies (small caps) and 15% in international stocks. The market obviously has more moves than Usher, so after 3 months you look at your pie and lo-and-behold you're holding the bag with only 30% invested in large companies and 35% in international. Why did this happen? Because the value of the large companies went in the toilet, and places like India and Brazil are wiping the mat with the big boys.

Rebalancing is what keeps asset allocation in check. What has increased in value, and therefore taking up more space in the pie, is sold, and then purchases the underperforming asset that has shrunk its section of the pie. You buy what's in the gutter for what's in the sky, and fall back in line with your original asset allocation. Historically and on average, asset allocation and rebalancing will give you the biggest pie; higher returns. It's also a little much to do in your free time on a quarterly basis, which is why a target retirement fund is a brilliant choice for those who want the money managers to manage their money for them.

But back to T. Rowe Price. I like them because when I first started out I had squat, and most funds require minimums. T. Rowe Price allows you to start with nada, so long as you do automatic monthly investments of at least $50 a month. Again, if you open a ROTH IRA, be aware that this year's maximum is $4,000 a year ($333.33/month), and *** you cannot invest more in an IRA than you earn in income***. In other words, what is reflected in your W-2 and/or 1099. Next year the maximum increases to $5,000. T. Rowe Price is hardly the only company. Both Vanguard and Fidelity have retirement funds, and they are well known and respected companies. Vanguard differs from other mutual fund companies, though, because their mutual funds are index funds. I'm a fan of index funds, funds whose holdings match the index they're tailing, but at the time I didn't have the minimum investment.

I would suggest googling around and learning more about these three companies, what their minimum investments are, and how their asset allocation differs. The highlighted links within this post should be helpful. Even if you only start out at $50 a month, and then every few months you jack it up a little until eventually you can meet the maximum contribution, it is better than nothing. Just start. Start researching, start sending for forms, start making money. Thankfully saving, like spending, tends to inspire more of the same.

Steering yourself toward retirement

If you want to be able to be seventy years young and not living like you're a nineteen year old street urchin, you better start steering yourself toward retirement now. It's kind of like mapquesting. You have a known point of origin, a destination that is unfamilar, and you need to know what roads to take to get there, distance markers along each path, and that it's almost gauranteed that the mathematical certainty of GPS coordinates matched with Rand McNally-like cartography will almost always be, at some pivotal point, outright wrong- to which end you will find out the hard way while you're mid trip and cursing the program that told you where to go.

The stats are sobering. In ten years it is expected that Social Security Trust Fund will pay out more in benefits than it will take in FICA taxes. By 2041 it is expected to run out completely. Just in time for our retirement. This is all from the horses mouth, or the 2007 Trustee report. Lots of things can happen to divert this- the GAO (Government Accountability Office) suggests that the year before Social Security goes bankrupt the shortfall could be met by cutting federal spending by 60% or by doubling taxes. Fun stuff. Or cutting Social Security and Medicare benefits. More fun stuff that won't happen on the Baby Boomers' dime, but on ours. All scenarios rely on politicians doing right by us. Therefore, moving right along...

Assume you will not see one penny of Social Security. Assume that unless you save for your own retirement your own damn self, you will be one piss poor i-pod deaf senior citizen. To get started we turn to the abacus. (Not really, but I saw you falling asleep at the wheel). Retirement calculators for people who freelance, or people who are in the restaurant & bar industry are about as helpful as an abacus. Why? Because online (and offline) retirement calculators take your pre-tax income and calculate Social Security taxes, after tax income, projected annual income raises, and other fun factors. All of which reflect the unpredictable to the straight up non-existent for a bartender whose entire income may be undeclared cash. Nevermind the fact that nobody is going to start voluntarily tipping $1.04 a drink instead of a dollar a drink, just because inflation went up 4% that year. So not only do New Yorkers live in a city that tends to have higher inflation and/or cost of living increases than the national average, freelancers and service industry worker bees have an income stagnancy not shared with many nine-to-fivers clutching contracts. I don't advocate tax avoidance, but let's just admit that everyone from your doctor (insurance co-pays are mostly paid in cash) to large corporations who DO exploit the tax code for their benefit in so many brilliantly legal ways that it makes people in the service industry seem soooo i-work-for-free, manage to jiggle the tax code, and move on from there.

If the online retirement calculators don't work, you have to come up with your own using a compounded savings calculator instead. I like Dinkytown.com's, which I used for the following example. First off, let's wrap our heads around the idea of inflation. In thirty years one million dollars will be worth just a hair over $400,000. In other words, 3% annual inflation (ie projecting how much things like the Consumer Price Index (CPI) go up, let's say your rent, the cost of dinner for two, utilities, etc.) means that in thirty years the buying power of a single dollar bill will have the same buying power as today's forty cents. And if you dream of retiring on a million of today's dollars, it will take you almost two and a half million dollars in 2035 to be worth equal buying power. Which means you better start saving now, because the statistics are outright scary if you don't.

But forget the million dollar retirement. Your destination is simply to be able to retire with as much money as you can save, by spending less than you earn and saving the difference. Let's say you're currently 35 and would like to retire at 65 but so far have nothing to show for it. So you start to sock away 10% of your income for retirement in a ROTH IRA. If you make $600 a week that's $240 a month. So if you have zero retirement savings right now, you save $240 a month for thirty years, you'll have $340,247 in the end. Don't let me lose you, if you know the difference between a fifteen percent tipper and a twenty percent tipper you can follow these numbers. Now this is the best thing about saving- compounded interest (which is tantamount to investment returns). Because while $240 bucks a month over thirty years is just $86,400 in money you put in, it's the 8% returns that have generated the other $253,827. That 8% annual (projected) return must come from the stock market. There is no other way for the small investor to generate a comparable return. I'll get into portfolio allocation later, but for now just know that in order for money to work for you, you have to be invested in stocks. And in order for you to get all of that money when you retire, you should invest in a Roth IRA, because all qualified withdrawals are tax-free. That's right, your Apple (AAPL) stock gains are all tax-free.

You should know that there are two different kinds of IRAs (Individual Retirement Accounts), the Tradional IRA and the more recent Roth IRA. The Roth IRA uses after-tax income (ie the cash sitting in your sock drawer) to invest in stocks and/or bonds, while the Tradional IRA uses pre-tax money (ie directly from your pre-tax paycheck). It's just a matter of when you pay the piper; in a Tradional IRA you pay taxes when you're retired and withdrawing the money, with the Roth IRA it's before you invest the money and have presumably paid regular income tax. The Roth IRA is better for people who expect to have a higher income tax bracket when they retire than they do now, and/or people who need the stock market's compounded return to come tax free, which is almost everyone I know. The idea is to pay the least amount of taxes, and for most it's before you invest, not after. The Roth IRA is your new best friend.

And if you are twenty five years old? Ten more years of investing $240 a month will bag you $778,033- more than twice as much money for less than half the amount of time and money invested. It's not that you can't afford to save, it's that you can't afford to wait. Because compounding interest/market returns work most of its magic in the later years. Obviously, years of an 8% average return on a few thousand dollars is nothing compared to years of an 8% return on a few HUNDRED thousand dollars.

Now that you know what to drive, next up I'll suggest where to park it. That and the shock and awe of what it takes to max out your annual Roth IRA contribution.