Investment Advice for (Almost) Everyone


Investment Advice for (Almost) Everyone

Do you like tunafish . . . or cat food. At the rate most American’s save, you are likely to be eating a lot of these “yummies” unless you start saving for retirement NOW (and that applies equally to all of you, no matter your age).

Most of us realize Social Security, as it exists today is simply not sustainable. At some time in the not-to-distant future, benefits will be cut and the retirement age will increase. When this happens largely depends on when Congress and the President get the cojones (including our female members) to address the problem of collectively paying out more than is taken in. When you include similar reductions in benefits and/or increases in payments for Medicare, future retirees are going to get less and pay more. I don’t want to spend too much time on why this is happening as it is not the main topic of today’s blog (and I don’t want to bore the rest of you away). Suffice it to say, retirement without a substantial non-governmental entitlement payment will not be pretty and certainly will not be the “golden years”.

In the interest of time and keeping your interest, I’m going to try to keep the discussion high level, so it will be heavy on big picture facts and light on statistics and formal backup.

Big Picture Comment #1- You Need Net Assets of at least 20x retirement spending

You will need to have total net assets (assets less any debt) of about 20x your retirement spending when you retire. If you are lucky enough to have a pension, you can count 20x your annual pension as an asset (assuming it is from a large and stable organization, such as the US Government, GE, a utility, etc.).

If you expect to spend $100,000 per year in retirement, you need net assets of $2 million. Note that any “extras” like college (or grad school) for the kids or weddings are dollar-for-dollar adds to your needs. A good rule of thumb is that you can spend 4%-to-5% of your assets every year. Since you will be getting some social security payment, I feel comfortable with a 5% annual drawdown (I know the math is not exact, but you will also spend more than you think, have higher medical bills, etc.).

Big Picture Comment #2- You Need to Save Now!

All I needed to know about finance, I learned during day one of Finance 101, “A dollar today is worth more than a dollar tomorrow”. Put in the context of saving, a dollar saved today, and properly invested (keep reading) will grow in a tidy sum.

The power of investment returns is such that if you start saving 35 years before retirement (age 30 for an age 65 retirement), $100/mo month will give you almost in $110,000 in real (adjusted for inflation) dollars. If you start saving 10 years before retirement, you would need to save almost $750/month to get to the same place (and that same $100/month would give you a puny $15,000).

Ideally, you should create a lifestyle where you save 10% of your family income for retirement. I know “life” happens and that is not always possible. Again, ideally you save more and have that cushion for when life happens. Keep in mind, you will spend about 40 years working and about 20 years not working (in retirement).  So, that long time from now retirement, is really a big part of your life and can’t be “handled” with a few years of sacrifice.  If a family making an average income ($73,000; average 2010 family income) saved 10% of their income for 35 years (which also assumes nothing up to age 30), it is quite possible for retirement to have income that exceeds annual income (when taking Social Security into account)! Not easy, but doable and certainly worth it! A family in the 75th percentile of income ($118,000) that saves 10% for 35  years would take an income hit at retirement, but would still have more than 80% of their annual pre-retirement spending (remember, you don’t need to save in retirement!).

If you are young and disciplined enough to start saving now, I say go for it (and applaud your maturity). It is easy to forgo a few dollars today for a huge benefit (financially and peace of mind in the future). I am focusing on folks 30+ in my examples, but saving early, due to the compounding effect is hugely beneficial.

Bottom line, save as much as you can as early as you can.

Big Picture Comment #3- Use Retirement Plans to Save

Free money- is always good.  Read on to learn more.

Most employers provide a 401k plan (or 403b) to workers. About half provide some level of matching. If you are fortunate enough to be matched, even better.

Saving in a retirement account, makes saving “cheaper” and easier, because taxes are deferred. For example, if your marginal tax rate is 25% (tax paid on last dollar earned), saving $10,000 only costs you $7,500 (you avoid paying $2,500 in taxes on that $10,000).

If you are married and both of you work and both of you have employer-sponsored matching , you want to be strategic in your saving and make sure you get the maximum match from each employer. For example, a typical match is 50% of the first 6% saved. In this case, you would want to divide your 10% to maximize your retirement savings. Assuming one person makes $70,000 per year and the other $30,000, the first would only have to save 7% of $70,000 ($4,900) and the second 7% of 30,000 (or $2,100) or $7,000 combined. Through the 3% matching ($2,100 from the first employer and $900 from the second), the total saved would be 10% of your income, or $10,000, at a cost to your family of only $7,000. When you consider you are not paying taxes on the $7,000, your true cost to save $10,000 is only $5,250 ($7,000 less $1,750 in avoided taxes)!

If only one employer offers a match, make sure you shift as much of the required savings to that person. There is no reason to “share” savings in retirement; always take the best deal. Remember, you always want “money for nothing”.

Big Picture Comment #4- Your Investment Needs to Grow

If you have $2 million at retirement (to fund your $100,000 per year retirement) and put it in the bank or in CD’s, you will basically be tapped out in 20 years. However, at retirement, you have a life expectancy of 20+ years (more like 25 for you and your wife combined, because someone will outlive the other) and who knows, you could live to 100!  But since you can’t time your spending so you run out of funds on day zero- as you don’t know when day zero is going to be, you need a cushion! Therefore, you need your money to work for you. I’ll discuss this in more detail in the next section, but bottom line- you always need to be investmed and growing your money!

Big Picture Comment #5- Stocks Beat Bonds

Stocks beat bonds. Period. Assuming you have a decent investment horizon, and you do, because you either have years until you retire or you have years to live when you retire (21 years, on average, at age 65), you need to consider the long-term. Long term, stocks will always beat bonds (Treasury’s or otherwise) or cash. Why?  Because return is always risk for return. That is why Treasury’s offer virtually zero reward (actually negative when inflation is taken into account, and you must take inflation into account)- because they are perceived by many to be the (literally) least risk investment in the world.

While it is impossible to predict the future, I think it is reasonable to assume stocks will return about 8% over the long-term (note that this is a lower projection than the 9.6% US equities earned on average through 1996). Assuming average inflation of 3%, stocks will provide a real (net of inflation) return of 5% per year. Many “experts” suggest using bonds. Personally, given a long time horizon, I think bonds will only drag down your long-term returns. I will grant you that investing only in stocks will give more increased volatility (changes from period-to-period), but keeping in mind you still have a 20+ year time horizon at 65 (and that you should expect to live to at least 85 no matter your age) and need to be thinking long-term. I suggest keeping your long-term (and it’s all long-term) portfolio in stocks. Now, I’m not saying you chase the latest hot stock.  I am saying you should invest in a diversified pool of stocks through low-cost index funds. Ideally, you want to have about 65% of your money in US stocks and 35% in foreign stocks (not just European stocks). You may say, aren’t foreign stocks risky? Well, yes there is risk, especially in the short-term (of course that is true of the US market as well), but in the long-term the rest of the world is going to grow faster relative to the US and having a diversified portfolio will reduce your risk and likely enhance your returns. Enhance? While the US continues to have a lot of advantages (especially compared to Europe), we are growing slower than the emerging global economic powers (Brazil, China, India, today- who knows what the world will look like in 20 years!)- keep in mind the base they are starting from (especially in terms of standard-of-living) and where we are today. I suggest allocating your money as follows: 40% to a low-cost S&P index 500 fund, 25% to a low-cost Russell 2000 index fund and the remaining 35% to a low-cost (are you seeing a theme?) global index fund. You can buy these funds as mutual funds or ETF’s (exchange traded funds; bought and sold through a stock exchange). If you are buying through a 401k, you may have limited choices. However, always look for an index, as opposed, to an actively managed fund. Index funds generally charge very low fees (and historically outperform actively managed funds on a net basis- so you are essentially paying more for an inferior product!). This is hugely important. If you are going to return 8% per year (5% after inflation) a small sounding 1% fee will eat over 10% of your return (1% / 8% =12.5% of your return, reducing it to 7%, or 4% after inflation)! Always look at fees/costs and pick the index with the lowest fees. Since an index basically copies a pre-determined basket of stocks, there can really be no performance advantage within an index type, the only way to gain an advantage is through higher net returns driven by lower fees!

I recommend (and use) discount brokers, ETrade (www.Etrade.com) and TD Ameritrade (www.TDAmeritrade.com); they are both strong, low-cost and full featured. Both charge under $10/trade (with some ETFs and funds at no cost) and both have robust research and sophisticated on-line trading platforms. I also recommend (and use) mutual fund companies Fidelity (www.Fidelity.com) and Vanguard (www.Vanguard.com).  There are, of course, other good discount brokers and mutual fund companies.

Big Picture Comment #6- Never Hire An Investment Advisor

There is an old saying on Wall Street, “Where are the customers’ yachts?”. Simply put, advisors make money from your money. The more they get the less you get. As I recommend index funds, with cost being the only reach variable, what are you paying for?  In today’s world, you can invest on-line and have access to all the research you need (if an advisor really had “inside information”, he would go to jail for using it). Simply put, unless you fancy yourself to be a modern-day Peter Lynch, buy index funds. You will save money, save time (researching individual stocks) and likely do (much) better. As I mentioned in the last section, assuming a return of 8% per year, paying 1% (or 2% sometimes) will cost you over 10% of your return. Interesting tidbit, Merrill Lynch announced that they are dis-incentivising brokers from taking on new clients with portfolios of less than $250,000. Why, because it is easier to make the large profits the firm wants from larger portfolios. Anyhow, unless you are really wealthy (the “1%” that is in the news so much these days), I would stay away from an investment advisor.

Why are investment advisors such a bad idea? First, you need to pay them. Lets assume 1% for them. Second, they will put you into the products their firm pushes. Lets assume 1%-2% extra for these products (in upfront fees or recurring costs, or both). Third, they push stocks from their research list, which you get after the “insiders”. Any benefit that may exist from proprietary research disappears the second it is “out”- you will not be buying in before the research is out.

I think I’ve said enough on this. Buy low-cost index funds. Buy them yourself. You are investing for the long-term, do not worry about ups and downs in any given year.

Let’s Recap

To avoid eating cat food, you need lots of money when you retire. Plan on taking out 5% of your retirement each year. If you want to spend $100,000 per year, you should retire with $2 million. Social Security and Medicare are not going to be as lucrative when you retire. The costs of the programs are unsustainable and will change.

Save early, save often. The power of compounding means modest savings early in life yields big dollars later. Remember, you work for 40 years and retire for 20 years.  Twenty years are a long time!  It is really hard to play catch up with respect to saving.

Always take advantage of free money. Save through retirement accounts like 401k’s and take maximum advantage of employer matches.

You are going to live for a long time- invest in stocks (and ignore the market). Diversify your stocks (US and International).

Buy stocks through low-cost index funds. Don’t use a financial advisor. Don’t buy an actively managed fund.

Good luck. Invest early, invest often and save the cat food for the cats!

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How to Legally Rip Off the Credit Card Companies


How to Legally Rip Off the Credit Card Companies

Did you know that credit card issuers engage in legal usury? While most states have laws limiting interest rates (including fees) to 18% per year, credit card companies often charge an interest rate that exceeds 25% and earn over 30% when taking late payment, over limit and other “junk’ fees into account. As credit card companies truly believe in win-lose behavior, I have long felt it is almost a duty to extract as much money as possible from these credit card companies.

Let’s talk about some strategies to make money from credit card companies.

Strategy One: Sign-up Inducements

As bank capital requirements have tightened, credit card issuers are increasingly looking for ways to increase their bottom line (at your expense). That has led them to be extremely aggressive with their inducements (come-ons in the form of cash or cash equivalent “points”) to new customers. Their business model says they can make-up the cost of the inducements by switching your business from another company and by charging you interest and fees. What I suggest is using these inducements to your advantage and (screwing the credit card issuers). As I write this, it is pretty easy to get the equivalent of $500 (in cash, points or the equivalent) simply by signing up for a credit card and making $3,000 or less in purchases. The strategy is simple, sign up for one (or more) cards, make the minimum purchases (NEVER carry a balance; always pay your monthly balance off on time), redeem the reward and putting the card in a drawer. You win big and as an added benefit, the issuer loses (big).

Let me give you tangible examples (these offers may change, but these or similar offers are commonly available) in declining order of value:

  • Chase Sapphire Preferred: 50,000 points (worth $500 in gift cards and over $600 in travel); you need to spend $3,000 within three months
  • Citibank ThankYou Premier: 50,000 points (worth $500 in gift cards and over $600 in travel; includes “free” companion air ticket); you need to spend $2,500
  • Marriott Rewards Premier (Chase): 50,000 points (worth about $500, free night and “Silver” status); get points after first purchase.

Sometimes the card issuers will provide targeted offers (not available to the general public).  You need to be smart about taking advantage of the offer (and identifying and following through on the reward conditions).  For example, this summer American Express offered me a $750 Home Depot gift card for getting a new Amex card (no annual fee in first year) and spending $2,000.  It took me about 30 seconds to send that offer in!  Even if you don’t want the gift card, there are secondary markets in gift cards (Cardpool.com and Plasticjungle.com) that can turn a gift card into cold cash (though you may get 80-85 cents on the dollar)!

Please be aware that your credit rating will decrease slightly with each application and you need good credit to qualify for these offers.  However, the opportunity to “make” as much as $1,500 for “free” is extremely exciting to me!  All of these cards waive annual fees for the first year.  At the end of a year, you can either drop the card (another small ding to your credit) or request to be transferred to a non-fee version (not available with the Marriott card, some American Express and most airline cards).  Often the issuer will either waive the fee or provide an inducement equal to the cost of the fee- your choice at that point.

Strategy Two: Maximizing Rebates

I have always liked the phrase from the old Dire Straits song, “Money for Nothing”.  For that reason, I charge every possible expense to get a rebate from the credit card company (except when I am charged a “convenience fee” to use my card).  I’m sure many of you do the same.  However, all rebates are not created equal.  For example, airline points are generally horrible (unless you are one of the three percent who uses their rebates for last-minute business class international travel).  One percent back is a bush league rebate.  I prefer cash or cash equivalents (points that can be turned into cash or gift cards at common retailers like Wal-Mart) that provide a minimum rebate of 2% (Fidelity American Express, no annual fee).  However, to maximize your “money for nothing” you have to use a couple of cards.  Chase’s Ink card gives you 3% back on gas, restaurants and home improvement store purchases.  The American Express Business Platinum card gives you 5% back on your cell phone bill, FedEx and at selected merchants.  The CostCo Amex (you need to be a CostCo member) gives you up to 4% (for the business version) back on gas purchases.  It does require a little juggling, but if you think before you swipe, you can get more than a little “money for nothing”.

Strategy Three: Gaming the Promotions

The credit card companies often try (and succeed) to manipulate your behavior be providing special deals like 5% off on a select type of purchase.  These are almost always not worth it- they tend to be limited to a certain spend per period and are really too complicated to keep track of.  However, sometimes you are presented with a lay-up that is too good to ignore.  For example, Discover (which I have had for years but don’t use except for promotional periods) offered me $1 back for the next 20 charges I make.  OK, not a huge amount of money, but easy to track.  Basically, every time I make a small purchase, I use my Discover card.  My effective rebate is about 20%.  Similarly, the Gap Visa I took out (but never use) offered a $20 “reward card” for making any purchase.  My point here is to take advantage of the offers, but don’t be so silly as to go crazy for an extra $3 per month.

Ground Rules

As I previously mentioned, every new credit card opened (or closed) has a small impact on your credit.  Generally speaking, I will consider dinging my credit for $100 in value.  However, in today’s environment I am holding out for $300.  You should have your own internal over/under as you evaluate offers.  This also holds true for stores that offer 10% off your purchase if you open a credit card.  Sure I want the 10% off, but I don’t want to ding my credit for a measly $15 bucks.

Remember, credit card issuers are out to screw you by every legal (and sometimes legally dubious) means possible.  Use their offers against them; take advantage of their promotions, but only on YOUR terms!