Legend has it that there was once a time when gasoline cost 35 cents a gallon, mortgage payments were $200 a month, and people pursued a career by getting an education or training in a field, finding a job with a good employer, and staying there for 30 or 40 years until they retired with a pension and a watch. Some of the legend is true--gasoline once did cost 35 cents a gallon and mortgage payments for many people were $200 a month, or even less (but they had to watch flickering black and white TVs). Spending one's entire working life at one employer was, in those days, probably more the exception than the rule. But the availability of defined benefit pensions (which promised a predictable amount of money in retirement) made doing so worthwhile.
Today, most people work for a half-dozen or more employers during their working lives, and the defined benefit pension is about as common as the brontosaurus. They usually don't work long enough at any one employer to qualify for a pension, and if they do, it generally isn't much of a pension. (Some companies have changed traditional defined benefit pensions to "cash balance" plans that supposedly favor newer employees but hurt the interests of long time employees; so don't think loyal and faithful service mean much.)
Today's way of funding retirement is the retirement savings account, such as 401(k) plans, IRAs, etc. Originally, these accounts were meant to supplement traditional pensions. But now, with defined benefit pensions going the way of the carrier pigeon, retirement savings accounts--especially the 401(k)--have morphed into the only show in town for a lot of workers. They have tax advantages (see Uncle Leo's Den at www.uncleleosden.com/Step12RetirementAccounts.html for a discussion of these accounts). But you can wreck your retirement plan every time you change jobs.
That's because every job change gives you an opportunity to withdraw the money in your 401(k) account. If you do, you'll have to pay federal and state income taxes on the amount withdrawn and also a penalty of 10% if you're younger than 59 and 1/2. Depending on where you live, you could lose half or more of the funds withdrawn. Even if you put the remainder in a taxable savings or investment account, its earnings will be taxed currently. So you lose the boost to your savings from compounding earnings on a tax deferred basis. Of course, if you spend the money, it's gone forever.
When you change jobs, don't withdraw the money in your 401(k) account. You'll have one or more of these options: (a) leave it in your old employer's 401(k); (b) roll it over into an IRA; or (c) roll it over into a 401(k) plan offered by your new employer). Compare the fees and expenses of these options, and the investment alternatives. Then pick the option that gives you the best combination of low fees and expenses, and good investment alternatives. If you have a small 401(k) balance with your old employer, it may not allow you to stay in its plan and may issue you a check for the balance. Be sure to contribute that money into an IRA or your new employer's 401(k) plan within 60 days. If you meet the 60 day deadline, you won't have to pay taxes or a penalty.
Let's say you change jobs 8 times during your adult working years. If you withdraw your 401(k) money each time, you'll have only Social Security and whatever savings you've accumulated in taxable accounts. If you keep the money in one retirement account or another, you'll have compounded your way to what will probably be a nice supplement to your retirement. (We discuss the power of compounding at http://blogger.uncleleosden.com/2007/04/love-in-time-of-financial-planning-part.html.) Resist the temptation to spend retirement savings just because you can. All of your retirement days will be long if you're trying to make a go of it on just Social Security.
Tech News: A new use for ring tones: attracting leopards. Just don't leave your cell phone on in the jungle. http://www.wtop.com/?nid=456&sid=1159321.
Showing posts with label 401(k). Show all posts
Showing posts with label 401(k). Show all posts
Thursday, June 7, 2007
Wednesday, May 16, 2007
Investing Made Simple
There's a simple way to invest that gives you the diversified portfolio designed for long term growth that financial experts recommend. And the best part of it is that you don't have to a lot of research into stocks, mutual funds or other investments. We're talking about lifecycle funds, which are also called target date funds.
Lifecycle and target date funds solve two basic problems investors face. First, you should diversify your investments, so that you don't have all your eggs in one basket. Typically, a variety of stocks and bonds is recommended. We discuss diversification in Uncle Leo's Den at www.uncleleosden.com/Step9ManageInvRisk.html.
Second, you should change the focus of your diversification as you grow older. In your 20's and 30's, your portfolio should be heavily weighted toward stocks, since they have greater potential for long term growth. Of course, stocks can nosedive in value if the market stumbles--and you can be sure it will stumble every now and then. But when you're young, you still have plenty of time to ride through market turbulence and profit from the next upswing. As you grow older, you have less time to recover from investment losses. Therefore, you should shift more of your portfolio into bonds and even money market funds in order to lock in the gains you've achieved and stabilize your financial foundation. We discuss the need to mellow your investment strategy as you grow older in Uncle Leo's Den at www.uncleleosden.com/Step10AgeDiversify.html.
Given the vast array of investments available, how could an ordinary investor figure out how to diversify, and then how to change the diversification appropriately over time? If you have time every week to devote to investment research and strategizing, you could probably do reasonably well. But what if you have a job to keep, kids to raise, housekeeping to do, and fun to have?
The solution is to invest in lifecycle and target date funds. These mutual funds provide a diversified portfolio for you. All you do is pay in your money and they automatically invest it in a diversified way. They have "target dates," which are years (usually in increments of 5, like 2010, 2015, 2020, 2025, 2030, etc.). You pick a year that's close to the time when you plan to retire. For example, if you were born in 1975 and expect to retire around age 65, you'd invest in a fund with a target date of 2040. Right now, this fund would probably be mostly invested in stocks (probably somewhere around 80% in stocks, with the remaining 20% in bonds). As you grow older, the management firm operating the lifecycle or target date fund will gradually reduce the stock portion of the fund's assets and increase the bond portion. By the time you reach 65, the fund might have something like 30% to 40% of its assets in stocks, and the rest in bonds and money market funds. This conservative allocation is meant to lock in much of your investment gains so that you'll have some certainty for your retirement finances.
As with any mutual fund, you should look closely at the fees and expenses of lifecycle and target date funds. Some are noticeably more expensive than others, and in the long run, high fees and expenses can be costly. Vanguard and Fidelity offer lifecycle or target date funds that have pretty low costs. Other mutual fund management companies may also offer low cost funds.
If you are a bit of a stock market buff, you may want to think about the diversification philosophies of the lifecycle or target date funds you consider. They tend to have slightly different approaches--some are more heavily weighted toward stocks, while others have a greater preference for bonds. Make sure you are comfortable with the fund's diversification philosophy. If you want some ideas as to what allocations might be suitable, take a look at our discussion of model financial plans at www.uncleleosden.com/Step16aModelPlans.html.
From your perspective, with a lifecycle or target date fund, all the investment strategizing and diversification happens automatically. You just pay in your money and the fund's managers do the rest of the work.
More and more 401(k) plans are offering lifecycle or target date funds as an investment option. If your employer doesn't offer them, lobby for them. They'll make the process of retirement saving much simpler for you. You can invest in these funds through an IRA--just open the IRA with the mutual fund management company offering the funds in which you are interested. If you've maxed out your retirement accounts and want to save more, you can always open a taxable account with a mutual fund management company and invest in a lifecycle or target date fund that way.
Doing things the simple and easy way means you're more likely to do them. We all recognize the importance of saving for retirement. Keep lifecycle and target date funds in mind as one of the easiest ways to build wealth.
Entertainment News: Celebrity phobias. You've heard of some of this stuff--claustrophobia, fear of flying, fear of heights, and fear of snakes. But pigs? Eggs? Ferns? Gerbils? Houseplants? Antiques? Silver cutlery? Bright colors? And chewing gum? We're not making this up. See www.nbc4.com/slideshow/entertainment/13331800/detail.html.
Lifecycle and target date funds solve two basic problems investors face. First, you should diversify your investments, so that you don't have all your eggs in one basket. Typically, a variety of stocks and bonds is recommended. We discuss diversification in Uncle Leo's Den at www.uncleleosden.com/Step9ManageInvRisk.html.
Second, you should change the focus of your diversification as you grow older. In your 20's and 30's, your portfolio should be heavily weighted toward stocks, since they have greater potential for long term growth. Of course, stocks can nosedive in value if the market stumbles--and you can be sure it will stumble every now and then. But when you're young, you still have plenty of time to ride through market turbulence and profit from the next upswing. As you grow older, you have less time to recover from investment losses. Therefore, you should shift more of your portfolio into bonds and even money market funds in order to lock in the gains you've achieved and stabilize your financial foundation. We discuss the need to mellow your investment strategy as you grow older in Uncle Leo's Den at www.uncleleosden.com/Step10AgeDiversify.html.
Given the vast array of investments available, how could an ordinary investor figure out how to diversify, and then how to change the diversification appropriately over time? If you have time every week to devote to investment research and strategizing, you could probably do reasonably well. But what if you have a job to keep, kids to raise, housekeeping to do, and fun to have?
The solution is to invest in lifecycle and target date funds. These mutual funds provide a diversified portfolio for you. All you do is pay in your money and they automatically invest it in a diversified way. They have "target dates," which are years (usually in increments of 5, like 2010, 2015, 2020, 2025, 2030, etc.). You pick a year that's close to the time when you plan to retire. For example, if you were born in 1975 and expect to retire around age 65, you'd invest in a fund with a target date of 2040. Right now, this fund would probably be mostly invested in stocks (probably somewhere around 80% in stocks, with the remaining 20% in bonds). As you grow older, the management firm operating the lifecycle or target date fund will gradually reduce the stock portion of the fund's assets and increase the bond portion. By the time you reach 65, the fund might have something like 30% to 40% of its assets in stocks, and the rest in bonds and money market funds. This conservative allocation is meant to lock in much of your investment gains so that you'll have some certainty for your retirement finances.
As with any mutual fund, you should look closely at the fees and expenses of lifecycle and target date funds. Some are noticeably more expensive than others, and in the long run, high fees and expenses can be costly. Vanguard and Fidelity offer lifecycle or target date funds that have pretty low costs. Other mutual fund management companies may also offer low cost funds.
If you are a bit of a stock market buff, you may want to think about the diversification philosophies of the lifecycle or target date funds you consider. They tend to have slightly different approaches--some are more heavily weighted toward stocks, while others have a greater preference for bonds. Make sure you are comfortable with the fund's diversification philosophy. If you want some ideas as to what allocations might be suitable, take a look at our discussion of model financial plans at www.uncleleosden.com/Step16aModelPlans.html.
From your perspective, with a lifecycle or target date fund, all the investment strategizing and diversification happens automatically. You just pay in your money and the fund's managers do the rest of the work.
More and more 401(k) plans are offering lifecycle or target date funds as an investment option. If your employer doesn't offer them, lobby for them. They'll make the process of retirement saving much simpler for you. You can invest in these funds through an IRA--just open the IRA with the mutual fund management company offering the funds in which you are interested. If you've maxed out your retirement accounts and want to save more, you can always open a taxable account with a mutual fund management company and invest in a lifecycle or target date fund that way.
Doing things the simple and easy way means you're more likely to do them. We all recognize the importance of saving for retirement. Keep lifecycle and target date funds in mind as one of the easiest ways to build wealth.
Entertainment News: Celebrity phobias. You've heard of some of this stuff--claustrophobia, fear of flying, fear of heights, and fear of snakes. But pigs? Eggs? Ferns? Gerbils? Houseplants? Antiques? Silver cutlery? Bright colors? And chewing gum? We're not making this up. See www.nbc4.com/slideshow/entertainment/13331800/detail.html.
Subscribe to:
Posts (Atom)
