Gen Y - Retire Rich!

Post #135 - Stay Away From Investment Professionals

Part 6: Let’s emphasize the important stuff (cont.)

There are about four zillion people, hundreds of corporations, and billions of dollars competing with me to give you advice about your investments. 

I don’t think I can win this fight.  I worry that over time you will lose sight of what I am telling you in this blog.

So I advocate three things:

1. Buy Dr. Bernstein’s book and Dan Solin’s book.  Keep them next to your bed and read them once a year to remind yourself of what you are trying to accomplish.
2. Write down your asset allocation plan for the same reason.
3. Stay away from the financial services industry and everyone involved with it.  If anyone asks you about your investments, tell them you don’t have any.  Then do some somersaults.  I find that this discourages further conversation.  Although my wife gets annoyed with me when I do it.

The first two suggestions are easy.  The third one is tough.  For instance, if you have a 401K at work, it is probably sponsored by some sort of financial guy who sold it to your boss.  How do you stay away from him (or her)?  You don’t.  And if you do somersaults at work you might be frowned upon.  Worse, you might have a relative, friend, or neighbor who decides to change careers and winds up getting a financial planning degree.  You can’t avoid these people easily.

Let’s think of a few good lines to brush off the financial services vultures.

“My spouse makes all the investment decisions.” –  This might get you off the hook with someone who doesn’t know you well, but it won’t cut the mustard with a friend, neighbor or relative.

“I don’t need any investing help.” – If you’ve read and understood my blog, this is true.  But it won’t stop a decent financial services person.  They have been trained to ask you hundreds of questions and keep bothering you until you wilt from exhaustion.  The next thing you know, they are at your house getting you to sign some sort of consent agreement.

“I spend every dime I make.” – This will work.  If you have no available cash, you are of no use to them. 

“As soon as I find out how much I owe the IRS in back taxes, I’ll call you.” – This will work really well.  Hardly any financial types bother Wesley Snipes any more.

“You need to talk to my trust fund administrator.” – This will stop them dead in their tracks.  If your money is tied up in a trust, they can’t get at it.  Plus, they know that the administrator is making money from the trust and would sooner cut her own heart out than give them a chance to invest some of the boodle.

I hope this helps you. 

By the way, Dan Solin and Dr. William Bernstein have nothing good to say about the financial industry.  So if a financial advisor gets by your defenses in the future, and actually makes some proposals to you, re-read their books immediately.  You will come to your senses pretty quickly.  If you don’t have time to read the books, at least wave them at the stock broker in question.  It might scare him off.

Post #134 - You Cannot Get Decent Returns Without Taking Some Risk

Part 6: Let’s emphasize the important stuff (cont.)

Higher risk generally provides better returns over the long haul.

That’s why I advocate that you youngsters in Generation Y take on a little higher risk with an 80/20 portfolio allocation.

If you can’t handle this level of risk, understand that your returns over the long haul will probably be lower.  Compensate for this by saving and investing more than 20% of your gross salary.

If you are 23 years old and find that you can’t handle any investing risk (or very little risk), then you are wasting your time reading this blog.

• Get a job with a company that offers an old fashioned retirement plan.  This will give you additional security when you retire.
• Consider money making hobbies like fixing up and selling old houses.  I know nothing about doing this, but maybe you are better able to handle the risk inherent in this type of endeavor.
• Seriously consider marrying someone rich.  I don’t care if they have bad breath.
• Recognize that you may never be able to retire.

I’m not belittling anyone who cannot take on a lot of risk.  It’s not something you have control over.  I’m just trying to explain your options.

Q&A #26: Short term bond fund yields are really low. What can I do?

Q:  Short term bond fund yields are really low.  What can I do?

A: As I write this answer, the yield on the Vanguard Short Term Bond Index Fund is 1.56%.  The government is keeping short term interest rates close to zero in an effort to help the economy.  When the government does start to raise rates, two things will happen to the fund:

1)    The net asset value will decrease (and it will stay lower until the government stops raising rates), because the bonds in the fund will have lower rates than new bonds that are being sold.  So the key is not to sell the fund until the government is finished raising rates.

2)    As bonds in the fund mature, they will do so at their face value (so you won’t see any loss).  They will be replaced with higher yielding bonds, so your income from the fund will increase.  Since this is a short term fund, the entire fund portfolio will turn over in 2-3 years

I don’t know when the government will start to raise rates.  Ben Bernanke hasn’t told me.

You could switch your money into the Vanguard Total Bond Market Index Fund.  This fund holds many different types of bonds with different maturities.  The current yield is 3.15% and the portfolio should turn over completely in about 4.5 years, which makes it an intermediate bond fund.

That’s my only option for improving yields.  It sounds like a no-brainer, but keep in mind that an intermediate term fund has more risk in a rising interest rate scenario than a short term bond fund.  Why?  Because it takes an extra two years for the portfolio to turn over, which means that the Net Asset Value will be lower for a longer period of time and the additional income won’t be fully realized as soon as with a short term fund.

I talked about the Total Bond Market Index Fund before.  Dan Solin recommends it in his book as one of only three funds you need to own (along with the Total Stock Market Index Fund and the Total International Fund).   He likes the diversification the fund offers.

William Bernstein thinks differently.  He feels that you should own a short term bond fund.  His reasoning is that inflation is the most serious danger to a bond fund.  Since a short term bond fund minimizes the impact of inflation (because the fund turns over so quickly), then that is the best one to own.

Back in post #69, I stated that it’s good to own the Total Bond Market Index Fund when rates are higher and expected to go down, and it’s good to own the Short Term Bond Index when rates are lower and expected to go up.  But switching back and forth between the two funds requires some degree of market timing, which I have been telling you doesn’t work.  It’s a better idea to pick one and just hold it forever.  So who is right?  Bernstein or Solin?

Now let me make the matter more complicated.  Read this article from Vanguard.  Bond Market Advice

The article explains that when the government starts raising rates (sometime in the near future) they will probably raise short term rates only.  This is an unusual occurrence, but the Fed has the power to do pretty much whatever they want.  It is important for you to realize that everything I have told you about bonds up until now is void if the fed decides to stimulate short term rates only.  That’s because everything I have talked about so far assumes that bond rates would rise and fall across the board.

The Vanguard guys say that if the Fed raises short term rates only, then:

“1-year returns for short-term funds could turn negative if short-term rates climb during the next year. This is because yields are lower today than in 2004–2005, and a climb during just one year would provide insufficient income to offset price declines.”

 

This is not the end of the world, since you are planning to hold your bond fund for a long time.  For one year, you will be unhappy, but in the long term there won’t be any real damage.  Remember that a short term bond fund turns over completely in 2-3 years and all the bonds mature at their face value, so as long as you are not selling, you don’t experience any losses if rates go up.  Eventually, things will return to normal.

We still need to decide.  Short Term Bond Fund or Total Bond Market Index Fund?  Vanguard’s Chief Economist, Joseph Davis, is quoted in the Vanguard article:

"Judging whether or not one specific segment of the bond market will outperform another segment over a certain time period is difficult because it involves being able to forecast the direction, magnitude, and timing of interest rate changes.  That's why it's important to remain well diversified."

For now, the Vanguard guys seem to favor the Total Bond Market Index Fund.

This is an extremely long way of saying that if you want to switch to the Total Bond Market Index Fund to pick up a few extra percentage points of income for the next year or three, go ahead.  That’s what I’m doing.  But I’m also making a note to watch the Fed’s actions.   I plan to switch back to the Short Term Bond Index Fund after they are done stimulating short term rates, because over the long term, I think that Bernstein is more right than Solin or Vanguard.

The downside to this strategy is that the government may decide to stimulate all rates, and not just short term rates, which means it would have been better if I just kept everything in the short term fund.  Man, can this stuff get complicated.

If you decide to just stick with the Short Term Fund, since you’re not planning on selling any time soon, that’s fine too.  The worst that can happen is you have a few more years of low returns.  That won’t kill you.  At least the money is safe, which is the primary reason for holding bonds.

Post #133 - Stick To Your Plan

Part 6: Let’s emphasize the important stuff (cont.)

If you follow my advice you will own funds that invest in Large, Medium and Small companies in the United States and all around the world.  These holdings will be fairly equally weighted between Value Stocks and Growth Stocks.  You will own a short term bond fund.  You may also decide to own an emerging markets fund and a REIT Index Fund.

What about Foreign Bonds?  What about Commodities?  What about TIPS?  What about vintage vinyl records?

Let’s not lose sight of what we are trying to do.

We are trying to build a diversified portfolio that won’t take a lot of time to manage.

You should be well enough diversified if you use the funds I recommend.  In fact, you are well enough diversified with the US Stock Fund, the International Stock Fund, and a Bond Fund.  Read Dan Solin’s book,   “The Smartest Investment Book You’ll Ever Read” for confirmation.

So there is no need to pull your hair out trying to add fifty asset classes to your portfolio.  I already told you that the single biggest factor of Portfolio Performance, by far, is your overall equity/non-equity allocation.

The second biggest factor that will affect your long term performance is STICKING WITH YOUR PLAN.

If you stick with your allocations and rebalance every year, you will do fine.

If your circumstances change dramatically, you may need to modify your plan.  As you age, you will want to modify your plan to take on less risk.  Other than that, stick with the plan.  That’s why I want you to write it down.  So you can re-read it from time to time to remind yourself of what you are trying to do.

So, let me repeat again what you need to do:

1. Concentrate on your career so you can earn a good salary.
2. Save 20% of your gross salary every year and invest the money in the funds I recommend.
3. Have a written asset allocation plan that is more heavily weighted toward equities when you are younger (80% or 70%) and gets a little more conservative as you age.
4. Stick with the plan, unless your life circumstances change dramatically or you find that you simply can’t live with the amount of risk you are taking.
5. Rebalance yearly.

That’s all there is to it.

This sounds easy, but it’s not.  It’s hard to stick with a plan when every asset class is losing money, as in 2008 and the first two months of 2009.

It’s hard to stick with a plan when everyone tells you that your investing ideas are boring.  They brag about their big gains in the futures market and show you the $10,000 pinkie ring they just bought.   The beautiful people laugh at you when you drive by their house in a used Volvo Station Wagon.  They smirk behind your back when you suggest dining at a BYOB so you can save on the cost of the wine.  They don’t invite you to their parties because your shirt has a Costco label instead of a polo pony. 

There are a few things you can do to fix this.

1. Tell people that all your capital is tied up in an incredibly complex off-shore investment strategy involving windmills powered by oil wells.  That should pique their interest.  If they ask for details, tell them you haven’t read the prospectus.  If they want to get in on the deal, tell them it’s closed to new investors.
2. Explain that your seemingly skimpy standard of living is a ruse designed to fool the tax man into thinking you aren’t wealthy, because you haven’t filed a return in fifteen years.

Do these things and you’ll be the person everyone points to when you walk into the library to take out a book.  They’ll be saying things like “He pretends he can’t afford to buy books because he’s outfoxing the tax authorities.  What a guy.”

Post #132 - Your Real Goal Should be to Not Die Poor

Part 6: Let’s emphasize the important stuff (cont.)

I keep talking about Dr. William Bernstein and how smart he is.  I can’t help it.  One of the things he says in his new book “The Investor’s Manifesto” is that we should “design our portfolios to minimize the chances of dying poor”.

In the beginning of the blog I talked about the fact that we want to retire with a big pile of cash.  Over the course of the past two years, I have given you advice that will help you get this big pile of cash.  But I remind you again that my advice will not make you super-rich, because it is a fairly low-risk strategy.  In other words, I am helping you design a portfolio that will minimize your chances of dying poor.  Good for me.  I should call Dr. Bernstein.  Maybe he’ll send me a letter of commendation.

Let me remind you about the things you should NOT do.

1. Don’t buy individual stocks.  Sure, if all your money was in Microsoft stock back in the 1970s, you would be incredibly rich by now.  But the odds of you finding the next Microsoft are close to zero.  So don’t waste your money trying to find a stock that will go up a zillion percent.  The people who do that have a goal of becoming rich.  They probably will die poor because they are taking too much investment risk.     
2. Don’t time the markets.  I talked about this a few posts back, so I won’t repeat myself.
3. Don’t change your investment strategy every few years because the guy down the street owns a fund that was super hot last year.
4. Don’t buy high cost funds.  Cost is the one variable you can control, so make sure your portfolio is comprised of low cost index funds.  Unfortunately, if you participate in a 401K and all the fund choices are expensive, you don’t have a choice.  Here’s a link to an interesting article about high cost 401K fund options. Beating Back the High Fees                               

Again, I remind you that there is no absolute guarantee about anything.  Our one big assumption is that the world will continue to be a better place to live.  If this assumption proves false, all bets are off.

Please buy Dr. Bernstein’s book and read it.  His advice is very similar to mine, and he’s a lot smarter than I am.  He’s also way smarter than any of the guys who try to sell you expensive investments.  When they show up at your door, you can wave Dr. Bernstein’s book at them and tell them to go away.  It works like garlic works on vampires.

Post #131 - Your Most Important Portfolio Decision is your Stock/Bond Allocation

Part 6: Let’s emphasize the important stuff (cont.)

Those of you who decide to invest via the Vanguard Target Retirement Fund 2050 can skip this post.  Vanguard makes all the decisions for you with the Retirement 2050 Fund.

Everyone else, pay attention.

When you are setting up a portfolio, how much money you allocate to equities versus bonds/cash will account for 90% of your future returns. 

My feeling is that you should aim for an 80/20 allocation of equities to non-equities.  No more than 80% equities.  It’s too risky.

It might take a few years for many of you to get to that allocation, since you have to build up a six month emergency fund and maybe a house fund when you first start working.   But eventually, you should get to 80/20.

There are two caveats to this advice:

• I cannot guarantee that an 80/20 allocation will perform better than a 70/30 or 75/25 or 65/35 allocation for the next 40 years.  All I can say is that riskier assets tend to perform better in the long run, and equities are riskier than bonds or cash.  Therefore an 80/20 allocation should do better.  Forty years from now you might look back and say “Hey, stocks sucked for the last forty years.  I would have done better with a 60/40 allocation.”
• You may not have the ability to handle an 80/20 allocation.  Not everyone can take the heat.  Unfortunately, the only way you will find out your risk tolerance is to experiment.  See what happens when the first bad market hits.  Then make adjustments (slowly and carefully, not in a panic) toward an allocation that is more agreeable to you.

If you had a $100,000 portfolio in 2008, and it was split 80/20, you would have seen the equity portion go down by 50% through early 2009.  Losing $40,000 is no picnic.  Since then, equities are back up about 50%, which means you are still down $20,000.  Isn’t it funny how if your portfolio goes down 50% and then goes back up 50% you are not back to even?  That’s math for you.  In any event, if you were able to stick with your positions and rebalance each year, you’d actually be down less than $20,000, because you would have been buying equities when they were cheap.  Good for you.  This proves you have the guts to be an 80/20 investor.

If you squawked like a chicken when your equities lost 50% and switched into 100% bonds, then you didn’t participate in the 50% rise we saw from March 2009 to the present.  Which means you are still down $40,000.  This should tell you that maybe you should not do any investing.  You are not equipped to take any risks.

If you are somewhere in the middle, did these symptoms occur during 2008 and early 2009?

• You couldn’t sleep.
• You switched some of your money from equities to non-equities, even though it wasn’t time to rebalance.
• When it was time to rebalance, you were afraid to move money from bonds to equities.
• You stopped contributing to your 401K.
• You drank copious amounts of alcohol to calm your nerves.

If any of these things happened to you, maybe you should shift away from 80/20 to an allocation that is less risky.   You need to be able to sleep at nights during bad market times.  So a 75/25 or a 70/30 allocation might be better for your temperament.

If you had very little money at risk over the last two years, you probably haven’t learned anything.  All I can say is; pick an allocation percentage that you think you can live with and adjust it during the next downturn if you find yourself guzzling Pepto Bismol.

I’m emphasizing this for a few reasons.  First, I don’t want you spending countless hours agonizing over whether to have 5% of your money in emerging markets or 6%.  Those kinds of decisions are trivial.  Second, I want you to realize that the major decision, the Big Kahuna, depends on something you really can’t control.  That is, your ability to handle risk.   And you won’t know if it’s the right allocation until 40 years down the road.

Keep in mind that if you start at 80/20, I don’t advocate that you stay there for the next 40 years.  As you age and your circumstances change, you will probably want to take less risk.  I’m at 50/50 right now and I’m comfortable with that.  Even though I cried a lot during the last two years.  If you’re still earning big bucks when you are my age, and have a really large portfolio plus a guaranteed pension, you might want to stay at 80/20.  Everyone will have a different situation.

Post #130 - Start Saving and Investing Early, and Don’t Stop

Part 6: Let’s emphasize the important stuff (cont.)

How important is it to start saving and investing early, and to keep saving throughout your life?

It is the key to your investment success. 

Let me make things really easy for you.  To be pretty successful without lifting an investing finger, all you do is:

• Make a decent amount of money
• Start saving early (20% of your gross)
• Invest the money in the Vanguard Target Retirement Fund 2050 (I talked about this fund in post #39)

These three simple things will put you so far ahead of most people when you retire that you will make pilgrimages to my gravesite to thank me.

Actually, I plan to be cremated when I die.   Saves money on a casket.  My ashes will be sprinkled over the local Blockbuster store, which guarantees that my son will visit me at least three times a week. 

Of course, you could improve your returns by reading the rest of the blog and spending an hour or two a year maintaining a slightly more complex portfolio.  It’s up to you.

The power of compound interest works for you when you save early.  A while ago I compared someone who started saving money at 22 versus someone who started saving money at age 40?  The one who started saving later in life had to save more than twice as much money (in total) as the one who started saving at age 22, and he still wound up with a lower portfolio at age 70.  Amazing, but true. 

Dr. Bernstein says “Save as much as you can, and do not stop saving until you die.”  That’s pretty clear.  I put a number on it.  Save 20% of your gross salary each year.  Why do I use a number?  Because I know Gen Y better than Dr. Bernstein does.

Bernstein thinks if he tells you to save a lot, you’ll immediately make a ten point plan to prioritize your needs versus wants, and cut your expenses back to the bone.  I know the reality:

• You will decide that three lattes a day is a requirement of daily living.  Can’t cut back on that.
• You’ll consider your I- phone and high speed internet to be a god given right.
• You’ll cut back in the really important places.  Less lettuce for dinner, for instance.  That should save a nickel a week.
• The net result is that your total savings will be miniscule.

That’s why I tell you the goal is 20% of your gross.  Hopefully it will make you realize that this is not a hypothetical.  This is real life and it’s important.

Post #129 - Don’t Assume You’ll Get a 10% Return

Part 6: Let’s emphasize the important stuff (cont.)

I rarely read the Wall Street Journal or the New York Times.  Both of them give me a headache.  I prefer USA Today.  I can get the news without being depressed.

But I was flying home from San Francisco last week and somehow got a free copy of The Wall Street Journal.  So I read it.  There was an article that Calpers (California Public Employees’ Retirement System) might have to lower the projected rate of return it expects to achieve each year.  Up to now, they’ve been assuming 7.75%.  The article suggested that Calper’s return in future years might be 5% or 6%.  Calpers hasn’t decided yet whether or not they will revise their projections.

There are two morals to this story.

First, if you’ve been thinking you’ll be getting a 10% return on investment for the next few years, forget about it.  Think a lot lower. 

Second, you should not ever try to predict what your future rate of return will be.

But wait.  Calpers does it.  Why shouldn’t you?

Because you are not a pension fund. 

Pension funds have to make these calculations, because the calculations determine the amount of money the various municipalities in California have to contribute into the plan each year to cover their future liabilities.

You are a person.  You don’t have to make any calculations about future returns.

Your internal logic should go like this:

• I’ll concentrate on my career.
• I’ll save 20% of my gross salary (or more if possible).
• I’ll invest my money in a basket of diversified low cost index funds.
• I’ll try not to make any major mistakes.
• I’ll take whatever returns the market gives me.
• I won’t take undo risks to try to improve my return.
• I’ll retire when I can afford to, whenever that may be.

Remember that your portfolio is set up to give you a return that is close to the returns of the markets in general.  This will be a better return than the vast majority of investors.  Dr. Bernstein calculates that you’ll beat 60-80% of investors.  Other people think you will beat as many as 95% of investors.

The key is that we are not trying to “beat the markets”.  So you don’t want to get caught up in projecting future returns of 10% or 9% or 8% per year.  If you do that, and the markets only offer 4% or 3%, you will be tempted to take on additional risk in an attempt to hit your magic number.  This is the road to ruin.

All you can hope to do is control the things that are within your power to control.  Namely, how much you earn (you do have some control over this), how much you save, and the investments you make.  Then hope for the best.

Post #128 - Forget About Timing the Markets

Part 6: Let’s emphasize the important stuff (cont.)

Long term investors (that’s us) do not time the markets.

Why?  It can’t be done successfully by people like you and me.  Maybe ten people in the whole world have the right combination of skills to time the markets correctly over a long period of time (without cheating).  We are not those people.

Aha.  I hear someone in the back row asking for proof.  Let’s examine the following quote: 

“Two days before a market low in March, a record seven out of 10 investors polled by the American Association of Individual Investors said they were “bearish” on stocks.”

This comes from a USA Today article that I tore out of their January 11, 2010 edition.   The article was written by Adam Shell.  He is talking about the market low of March 2009.

Mr. Shell goes on to say that at the end of 2009, stocks were up 65% from that low point in March.   Which means that those 70% of investors who were bearish in March were dead wrong.

What about professional stock people?  They must have known that the market was turning around, right?  No.  Not right.  Mr. Shell’s article points out that about 47% of stock newsletter editors were bearish in and around March 2009.  These guys are the experts.  The ones we pay to tell us which way the market is heading.  Almost half of them were bearish at the point when the market was turning around.   Instead of buying a newsletter, you could have flipped a coin to tell you which way the market was headed.  The result would have been just as accurate (50/50).

If it’s so hard to call one market turn, imagine trying to figure out all the market turns.  You can’t do it.  Don’t try.

Instead, just save and invest your money on a regular basis. 

Post #127 - Live Simply

Part 6: Let’s emphasize the important stuff

Dr. William Bernstein has written a new book.  Buy it.  Read it.  Keep it.  The name of the book is: “The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between”.

I haven’t bought it yet.  As I write this post, I am in San Francisco for a few weeks.  I don’t want to carry the book home on the plane.  So I am sneaking into bookstores and reading sections while I drink tea.  Apparently, reading books without paying for them is legal in this town.  As long as you don’t remove the books from the stores.

Anyway, this book, along with “The Smartest Investment Book You’ll Ever Read” by Dan Solin, are the only essential investment books you need to have on your bookshelf.  They are both small and easy to read.  Both authors give advice that is very similar to mine.

One thing Dr. Bernstein tells us in his book is to “Live Simply”.  I love those two words.  They embody a lot of the things I have been telling you.

• Concentrate on your career.
• Don’t spend a lot of money.
• Don’t try to keep up with the neighbors.
• Don’t hang out with people who are richer than you.
• Don’t own too many funds.
• Don’t spend a lot of time worrying about your investments.

Look at Warren Buffett.  He lives in the same house he lived in for the last four hundred years.  His house is in Omaha, Nebraska for gosh sakes.  He spends his days reading the newspaper.   For fun, he watches the local minor league baseball team play.  OK.  He owns the team.  But still, that’s living simply.

You should live simply, too.  Here are some helpful ideas.

Don’t own too many toys.  If you own two houses and rent a summer place, how much money will be left over after you pay the mortgages?  Not a whole lot.  Plus, there is the added stress of remembering which clothes you keep in which house.

Don’t have more than one significant other.  Tiger Woods couldn’t handle it, how can you?  OK, Tiger is an exception.  He had lots of significant others, if we believe everyone who lined up for their fifteen seconds of fame.  Look where it got him!

Do not get one of those Internet phones.  This is where we have a generational misunderstanding.  I think the phones are too expensive and will do irreparable damage to your thumbs.  You think they are more essential than multi-grain bread.  Let’s agree to disagree.

Don’t join too many organizations.   It’s fine to have a few activities outside of work and family.   But if you spread yourself too thin you will neglect your work and your family.  Don’t do that.  It leads to a resentful spouse, kids who don’t talk with you, and an unhappy boss.

As the years go by, keep remembering to Live Simply.  You will enjoy your life more.  Financially you will end up better off.