4 Types of People saving for retirement: why you should be an active participant with your financial adviser
I think there are 4 types of people when it comes to saving for retirement.
1. The Do-It-Yourselfer: This person loves researching and learning about portfolio construction. They understand proper allocations giving their age and risk thresholds. They actively rebalance their portfolio. They have other savings accounts outside their 401k. (Beware the person that thinks they are in this camp, but is simply trading gold, penny stocks, or isn't diversified at all. That client is basically an "Osterich" because they aren't executing proper risk management and diversification).
2. The Osterich: This person has their head in the sand aka doesn't know what the hell is going on. This person isn't really saving beyond their 401k (or maybe not at all), and they don't really look at the details of the 401k either. They have no idea if their 401k money is in a money market account, earning nothing, or if it's 100% in commodities, or if it's actually in a proper allocation given their time horizon and risk threshold. This is probably the worst position to be in. If you aren't saving, or aren't saving properly, you need to re-evaluate things right now.
3: The Osterich Plus: This person is like the Osterich, but at least they are letting a professional help them. While the Osterich's relationship with their adviser should be trusting, they should still have an idea about what their money is doing and how it is working for them. Osterich's don't -- their head is in the sand. Make an attempt to understand what your money is doing. If your adviser isn't willing to explain it to you, consider getting a difference adviser.
4: The Active Manager: This person is too busy to keep track of the swings of the market, but they do have a more collaborative/understand role in their financial adviser's management of their money. These clients make the attempt to understand where their money is going and why. When their quarterly, bi-yearly, or yearly meetings come around, they understand the portfolio steps that the financial adviser is suggesting. They understand the need for emergency cash funds, access to funds, and protection of their income. They can also explain how and why their money is currently allocated a certain way. They know from working with the adviser, that they are on track to reach retirement savings goals.
In my opinion, #1 and #4 are the only type of clients you should be. Either learn it all and do it yourself, or let someone that does it for a living manage things and have them explain why they are allocating your money a certain way. You HAVE to understand where your money is, and how it is working for you. You HAVE to understand if you are saving enough to reach retirement goals, or if you need to make adjustments.
When I work with people, one of the 5 main goals I go over when I first meet a client is that "they need to know where their money is and what it is doing for them." They don't have to know the Sharpe Ratio of their portfolio (although that would be nice), but I want them to understand: how their portfolio is set up; general principles of portfolio diversification, dollar cost averaging, & valuation; the need for liquid emergency funds; protection of income; and the role taxes play on retirement savings.
We can talk about saving to reach a large amount until we're blue in the face, but there is something else that is probably the first step in our process.
It is imperative that we have enough money set aside for emergencies. This is even more crucial for families, and the most important if the household is dependent on 1 income.
A layoff, injury, firing, can crimp income in such a way that mortgages and other bills can't be paid. That is why we suggest people set aside enough money to last at least 6 months. Setting aside enough money to cover a whole year worth of mortgage/utilities/grocery costs is even better.
So when you are starting your financial planning to get to the place you need to be, don't forget the first step. Set aside cash in an account that you won't touch unless it is an emergency. I often suggest opening a savings account at a bank far from your house, so you don't get in the habit of touching the money. Other options include saving to a taxable brokerage account that is in very liquid, investments. This can provide a return on the money, which can negate the effects of inflation.
So calculate what you spend per month on mortgage, utilities, and groceries, (and other essential expenses) and multiply it by 6 months. That is how much you should set aside, at a minimum. If you feel ambitious, multiply by 9 months or 12 months.
So what are you waiting for. Start saving from your paycheck to that Emergency Fund. Once is is full, you can plan higher earning accounts/methods.
Sometimes you find people that say pets are expensive so you should not have them.
I will grant that in some situations, a person should wait to get a dog or cat, because their budget is just too strained to afford the cost of dog food and medicine.
That said, it is hard to quantify the benefits of the happiness that animals can bring you.
My girlfriend and I recently decided to foster a dog with terminal bladder cancer. He has spent 4 years at a shelter (where my girlfriend used to volunteer before her job got too busy), and we couldn't see the sense in having him spend his remaining days there. It is a great shelter, but he's getting older and the sound of dogs barking constantly has to be annoying, even for a dog.
So we are fostering Bam Bam. He is the sweetest dog I've ever had, despite his brawny appearance. He is also much nicer than our small dog.
So for whatever time he has left, we are Bam Bam's family, and we do enjoy his company. I will probably post a little more about Bam Bam as Winter approaches, since he may only have a couple months left.
This week I worked with a couple in their late 60's. It started out as a regular planning session (that is what I do) and we quickly narrowed in on their particular needs. They had saved up a substantial amount of money for their own retirement needs, but there were two things they still wanted to accomplish. They wanted to plan for the possibility of nursing home care and they wanted to know if they had enough money to save for their grandchild's potential educational needs, while still leaving them enough to live comfortably on.
Both of these are common needs for clients in retirement. The long term care needs are important because the cost of nursing homes is growing at a very high rate. It can cost upwards of $90,000 per year for private nursing homes. The cost of long term care can easily make inheritance by the next generation a no-go. This is a very important point. One of the most direct ways to tackle this issue is with GOOD long term care insurance. "Good" is in caps because there are many subpar long term care insurances out there. They may be cheaper than the good ones, but they also don't tell you that they may raise their rates in the future, so what seems like a good deal isn't one. We discussed three main options (which I may talk about in a future post )and they are deciding which best fits there situation. I will be meeting them again in 2 weeks to discuss again with them.
I provided 2 options for funding the grandchild's education and they immediately chose 1. The grandparents decided to fund a whole life policy on the child. This is one common method (the other is a 529 plan). There are advantages and disadvantages to both, but appealed the most was the certainty of the 10 year whole life policy. Cash values in whole life do not go down. After all, the policy is a contract. So when we provided an illustration that showed how monthly payments for 10 years would grow to provide for substantial educational needs, and still leave money left over to help the grandchild afford a down payment on a first home, their mind was pretty well made up.
They knew their kids (the grandchild's parents) could still start the 529 plan, and they liked the idea of having multiple funding sources for the grandchild's education. Finally, they liked that they could also likely help the grandchild put down a down payment on a house, an option they never had as young adults. They knew the benefits of home ownership, including: building equity, lower payments than renting, and lower rates for a larger down payment.
I will probably fill you in on the long term care option when I meed with the clients again.
Good night and good luck.
Diversification. You've undoubtedly heard the word. You probably even know what it means, and in what context it gets used most often. Yes, diversification is used most commonly when speaking about investment strategies.
So in the previous post, we discussed a rough approximation of how you can get to $10 Million in savings. The ways we can drive revenue to put into our savings account will be discussed in future posts, and mainly focuses around developing passive income strategies. But it is also important that we know how we will be deploying that passive income in our savings vehicles.
That is where the concept of diversification comes in. As much as we'd like to find one stock that will go up 10,000% in the next 20 years, there is almost an infinitesimally small likelihood we will be able to do that. Unforeseen events and competitors make that unlikely. It's more likely that something bad will happen to the stock over that time span, and we will lose a chunk of our investment. That is why we diversify. It is a much better idea to spread our risk over various stocks and asset classes, and simply count on the benefits of capitalism, economic growth, and interest rates to help us in the right direction. So spreading money across many stocks can help prevent the fallout if one stock fails. But what about market-wide, or sector-wide declines, like the '00 Internet Bubble/Crash, the '14-'15 Oil Crash and the '09 Housing/Financial Crisis? How do we mitigate their affects? The same way we do for an individual stock. We diversify across different sectors and different asset classes.
What does that mean? It means that you don't put all your money in one stock, and you generally don't put all your savings in only one type of stocks. You spread it between big and small stocks, growth and value stocks, US and international stocks, bonds, REITS, commodities, cash, etc.
What does this diversifying do in a nutshell? It lowers the correlation within your investment portfolio. That means that one component does not act like another. If one sector like Retail stocks goes down, another like Utilities, may do better. If stocks as a whole under-perform, bonds may be more likely to outperform. If stocks go down, real estate may keep going up. These aren't certainties of course, but we seek to hold assets that react differently to different situations.
There are long run benefits to this as well. We don't just do it to protect our money. It acts to increase returns in the long run. For example, ETF.com wrote an article on correlation and has an illuminating quote:
"The most dramatic impact in the portfolio comes when adding commodities as the seventh asset class. This multi-asset portfolio was comprised of large U.S. equities, small U.S. equities, non-U.S. equities, U.S. intermediate-term bonds, cash, REITs and commodities—each asset class having a portfolio weighting of 14.3 percent. The seven-asset portfolio had the highest return (11.25 percent), the lowest standard deviation of return (8.67 percent), the lowest aggregate correlation (.128), the smallest maximum one-year drawdown (-10.2 percent) and a zero frequency of a 10 percent loss (as measured by IRR) over one-, two- and three-year periods. (The -10.2 percent maximum portfolio drawdown is, by necessity, calculated differently than IRR).
... The key point here is that highly diversified portfolios with low aggregate correlation tend to avoid losses, which essentially negates the need for a high recovery probability. In sum, the probability of recovery from a 10 percent loss within three years is slightly lower in the more diversified portfolios, but the frequency of 10 percent or higher losses is nearly eliminated."
So there you can see the benefits of lowering correlation by diversifying among asset classes, sectors, and definitely beyond individual stocks. We minimize huge losses, and therefore don't have to do as well to recover.
Did you notice something else? Just by diversifying between these asset classes, we have almost achieved one of our goals of 11.5% annual returns (see our second blog post). This is the number that we needed to achieve to reach our $10 million dollar goal!
So there you have it. A diversified portfolio is essential to reaching our goal, so is there any other reason not to do it? Tune in next week for further discussion on Asset Class Allocation.
There are so many things to cover over the course of this blog's lifespan. It is part educational and part diary, because as I write I am implementing ideas.
As a financial adviser, and former lawyer, I have seen many wealthy people come into my office. There are frequently vast differences in how they arrive at their wealth. Some people have great jobs and average savings habits, and those people can accumulate significant wealth.
Some people have more mundane occupations and businesses, and yet they can accumulate unbelievable wealth.
This blog seeks to examine the ways that the more mundane occupations achieve significant wealth, because the people with high paying occupations can use the same methods to grow their money.
Some of the topics we will examine are: the time value of money, diversification, asset allocation, stock investing, ways to goose stock investing, ways to achieve passive income, and ways to measure whether an investment is a good opportunity or not.
With that intro, I'd like to start my first "real" post...
The title of this blog is kind of audacious. $10 Million? Really? I know for some people it seems way off. But the whole concept of this blog is to develop a path for someone that is 30 years old, and without much in the way of assets, to find a way to $10 million dollars by age 65.
I chose $10 million because thanks to inflation, $1 million probably won't be enough to live well in 35 years. I also think it is still an achievable number for most middle class individuals. Working backwards, we can arrive at weekly savings goals, and annual returns on our saved money/assets.
With that said, let's begin calculating what it will take. Assume we can begin saving $100 every week. (This amount might seem like a stretch, but the whole point of this blog down the road is to evaluate ways to bring in this money).
We begin saving $100 per week, and every year thereafter, we increase that weekly amount by $50. So in year 2 we save $150 per week. In year 3 we save $200. In year 4 we save $250. And so on and so on. You may be asking how we will afford to raise this amount every year, but the answer will be through passive income streams. We will spend many many blog posts discussing these. If you work along with the blog and add a passive income source every 6 months, you will be able to increase this weekly savings number every year.
So $100 per week the first week, and then increasing $50 a week every year after. You need to make annual returns of 11.5% to have $10,456,620 at age 65. I think many financial "gurus" overestimate projected annual returns on stocks going forward. People forget that: 1) the U.S. benefited from the destruction of Europe's industrial capacity during WW2, leaving us the only game in town; 2) the fall of the Soviet Union in the early 1990's left us as the lone super power for 2 decades; and 3) the Federal Reserve has been manipulating the economy through monetary policy since the 1980s. Our stock returns since WW2 may very well be higher than we should expect going forward.
So for that reason, lets assume stocks only average 8-10% going forward. Just to show you the power of compounding interest, can you guess what our savings total comes to if our annual returns only average 9%, rather than 11.5%? $6.6 million... So a 2.5% difference in annual returns can mean the difference of almost $4 million dollars ($10.456,620 - $6,630,007 = $3,826,613) when we hit age 65.
So how are we going to try and reach 11.5%? Patience grasshopper. There are ways to try and increase equity returns. We will discuss these strategies going forward. For now just know that we need to start thinking of ways to save $100 per week from our income.
Until next time. Good night and good luck.
I am a Chicago-area financial adviser to young doctors & business owners.