Gen Y - Retire Rich!

Post #79 - This is a good time for Gen Y investors

Post #79

Part 3: Money and Investing (continued)

This is a good time for Gen Y investors
You guys are lucky. 

Equities and housing is fairly cheap by recent standards.  Now is a good time to be buying them.

Of course, after the incredible drops of the past year, not too many people are hocking their Webkinz to get more money to invest in stocks.  They are still shell shocked.

I’m not suggesting you do anything drastic.  I’m merely pointing out that things are cheaper right now.  Stick with your plan of saving and investing regularly.  Rebalance yearly.  If you were thinking of buying a house in a few years, maybe now is a better time to be buying.  Of course, Manhattan, and some parts of California have not shown price declines, but other places are looking pretty cheap.   

As you invest, make sure you re-read my advice in post #45 about being tax efficient.  Let’s face facts.  Taxes will go up sooner or later.  Our country really needs the money.  I don’t know when the tax increases will happen, but you can count on them.

You have to pay income tax on interest and dividends you receive from investments you own in your taxable account.  You have to pay capital gains tax when you sell one of your taxable account investments for a profit.  You have to pay capital gains tax when a mutual fund in your taxable account gives you a capital gains distribution. These taxes are due by April 15 of the year after you get the money.

If you own an IRA or a 401K, the tax for these things is still due.  But the tax is deferred.  You don’t have to pay the tax until you actually start taking distributions from your IRA or 401K.  And the tax on these distributions is an income tax, not a capital gains tax.

Luckily, you won’t have to pay tax on distributions you take from your Roth 401K and Roth IRA, provided you take the distributions properly.  This is why I recommended early on that you use the Roth 401K and Roth IRA (if possible) instead of the regular 401K and IRA.  Please re-read posts 28-31.

Just like inflation, you have no control over the tax rates.  You can minimize your taxes by owning index funds and keeping REITs and bonds in your retirement accounts.  But you can’t protect yourself completely.  We have to pay the piper eventually.  All the more reason to save and invest as much as you can.  The bigger your pile of money, the more you will have after inflation and taxes.  It’s way better than not saving and hoping the government bails you out.

Post #78 - What kind of return can you expect from your portfolio?

Post #78

Part 3: Money and Investing (continued)

What kind of return can you expect from your portfolio?
The size of your pile of money when you retire will depend on three things:

1. How much you can save and invest.
2. How long the money is invested.
3. The average annual return you achieve.

You have control of numbers 1 and 2.  Number 3 is up to a higher power.  Not your mother, the market.  This last year should have given you enough evidence of that.

Back in post #43 I suggested that a Basic Allocation can be achieved using just four funds.  Let’s look at their average annual returns over the last ten years, as of 11/30/08?

Vanguard Prime Money Market Fund                               +3.50%
Vanguard Short Term Investment Grade Bond Fund         +3.81%
Vanguard Total Stock Market Index Fund                        –0.22%
Vanguard Total International Index Fund                        +1.3%

• For one of the few times in history we have a ten year period where holding US stocks produced a negative return.
• International stocks performed slightly better than US stocks.
• You were better off having your money in a Money Market and a Bond Fund.

Should you conclude that going forward it’s better to put 80% of your money in bonds and only 20% in equities? 

No, that would be a bad conclusion.  You still want most of your investments in equities.  I will repeat some words I wrote way back in Commandment 5.

Higher risk investments usually offer the potential for higher rates of return.  Otherwise nobody would buy them. 

That’s the reason in a nutshell.  Equities are more volatile than bonds and money market funds.  Higher risk usually translates to higher payoffs over the long term.  That’s why you invest in equities.  Here’s a link to prove I’m not the only goofball telling you this. Why Invest in Equities.  Just remember that this advice does not necessarily work for older people who have shorter time horizons.

Unfortunately, when you invest in equities you have no control over the market’s rate of return.  So don’t worry about it.  Concentrate on what you can control.

• Save as much as you can.
• Keep your costs and your taxes low (which is why we use low cost index funds).
• Invest for as long as possible.
• Don’t make any dumb mistakes, like trying to time the market or abandoning your plan or investing in high cost managed funds.

Just remember that in the long run, if you follow my advice, you will do better than the vast majority of investors who are making tons of mistakes.

Post #77 - Bernie Madoff and Greed

Post #77

Part 3: Money and Investing (continued)

Bernie Madoff and Greed

O boy, did old Bernie make everyone look stupid.  He’s worked a giant Ponzi scheme for years and caught a lot of supposedly smart people in his net.  Check this link for a partial list of names.  List of Madoffs Victims Keep Growing.

You guys can take a lesson from this.  Greed trumps intelligence most of the time.  When people see their friends getting annual returns that are really sweet, they get envious and then greedy.  They can’t wait to join the party.  They never bother to kick the tires or look under the hood.  Eventually, they get screwed.

Bernie Madoff scammed a lot of braniacs, as well as some of his best friends.  I feel sorry for the ones who couldn’t afford to lose that money, but caveat emptor.  Let’s not bail them out.

How did so many smart people get scammed?  It all comes down to greed and foolishness.  Here’s a good article.  Madoff article by Jeremy Warner

The author points out that people who did their homework should have seen the warning flags about investing with Madoff.  

Still the SEC looked at his investment funds twice and didn’t find anything.  So he was obviously a pretty good swindler.

So let’s see who Madoff suckered:

1. Good friends and people who had been his clients for years, probably before his scheme turned into a scam.
2. Those who trusted their financial adviser to pick the right investments for them.  Spielberg and Katzenberg may fit into this category.  They were too busy with their own professional lives to double check what was happening with their investments.  Read this article: Steven Spielberg among victims of Madoff scam. 
3. Those who didn’t know they were investing with Madoff.  They invested with a “fund of funds”, and that fund put the money with Madoff.
4. Those who either were too lazy to do any investigation, too inept to see the warning signs, or too enamored with the returns to bother about the warning signs. 
5. Those who decided to invest after the SEC found no wrongdoing.  If I was checking into an investment and the SEC had just investigated the place, it probably would have scared me off.  Even if the SEC said they didn’t find evidence of fraud, just the fact that they needed to investigate would have deterred me.  But I guess there were many people who might have invested after the investigation.  They probably figured “no harm, no foul”.  Now they know that you can’t trust the SEC to do your homework for you.

Greed and foolishness factors into the decisions made by each of these groups:

• The group 1 people were both foolish and greedy.  Foolish because they assumed that a good friend would never do them dirty.  Greedy because a lot of these people didn’t diversify their investments adequately. 
• The group 2 people were foolish.  They remind me of the big time athletes who make loads of money and wind up broke because their managers and accountants swindled their money away over the years.  You can never be too busy that you lose track of your money. 
• The group 3 people were foolish, because they assumed their fund of funds would perform due diligence for any investments.  Tough lesson to learn.
• The group 4 people were either foolish or greedy or both.
• The group 5 people simply got screwed.  Still, they should have smelled a rat since the SEC investigated twice in four years.

Here are the important points of the day:

• Don’t be greedy when you invest.  If something seems too good to be true, it probably is.
• You are responsible for your money.  Don’t trust financial advisers too much.  Most are ethical, but many are not.  When I was selling insurance, I knew financial advisers who would sell their customers the products with the highest commission, and not the products that were the best for the customer. 
• Don’t invest in a fund of funds.
• Don’t assume that something is legit if the government investigates and doesn’t find any fraud.  All that might mean is that the government investigators are not as sharp as the scammer.

If you follow the advice I have been giving you, none of these will ever apply to you. 

Remember this!  A good con man can always get around the system.

So the only defense against being on the short end of a long con is you.  Don’t be greedy.

Post #76 - Who is this guy they call Dr. Doom?

Post #76

Part 3: Money and Investing (continued)

Who is this guy they call Dr. Doom?
His real name is Nouriel Roubini.  He is the expert of the year, since he predicted the severe problems we are experiencing.  Check this link and listen to the video:
Why Is Roubini's 401(k) All in Stocks

• He thinks things will get worse before they get better.  My note: Just because he’s been right so far does not mean that he will be right on this call.  He may be, but he may not be.  Only time will tell.
• He tells you that he is a long term investor.
• He has all of his 401K money in stocks because they will do the best over a 10 or 20 year period.  He says this in the video.

The good news is that he believes the long term prospects of the markets are good.  That is what this whole blog is about.  He backs that up by having his 401K in stocks.  He didn’t try to time the markets in the past when he was predicting the doom and gloom that is occurring right now.  That’s because he knows that market timing is not for long term investors.

Follow Nouriel’s actions.  Put most of your investments in equities and be secure that over the long haul (many, many years) they will do the best. 

Note that in the video he tells active traders to stay away from equities for now.  He gives them different advice, because they are not long term investors.  Remember this when you hear other people give advice that runs contrary to what I have been telling you.  They are probably talking to active traders and not long term investors.