Investing FAQ
Here are some common questions about investing that can hopefully be cleared up:
1) Is investing safe? The safer the investment, the lower the returns (and with annuities and cash value life insurance, higher costs). The investments outlined on this website though index funds are more risky than the proverbial cookie jar or mattress, yet much less risky than the roulette wheel in Vegas. Put another way - most of you that own a home are taking a very real risk - the loss of principle on the home. It is an educated and wise risk to invest in both the stock market as well as your house with the hope that both will go up in value as they have done so historically over a long period of time. The best way to hedge risk is through proper allocation of stocks and bonds and owning a diversified portfolio of index funds that buy the entire market over many years.
2) How much do I need to retire? Nobody really knows and everyone's situation is different. I suggest finding a retirement calculator or a simple compound interest calculator online to do some calculations. If you are receiving a pension, you will have some retirement income plus a little from Social Security. For me, that will be roughly half of my top salary in retirement, so I am going to invest to supplement at least some of the difference. To make your money last as long as you do, you will want to plan on a 3-4% withdrawal rate with about a 50/50 stock/bond allocation. If you wish to supplement $25,000 of income per year at a 4% withdrawal rate, you will need a nest egg of $625,000 (25,000/.04). To have $625,000 by retirement at an 8% rate of return, you will need to save about $21,000 per year for 15 years, $12,750 per year for 20 years, $8,000 per year for 25 years, and about $5,150 per year for 30 years. These are rough numbers, and no guarantee, but at least they are a start. If you won't need that much, then of course you won't need to save as aggressively. $100 per month started at age 25 through age 65 at 8% return will be over $335,000!
3) How much should I save now? Sort of answered in #2, but a good range is to save about 10-15% of your current household income towards retirement after you have all of your high interest (preferably all) debt paid off and have a 3-6 month emergency fund. If you make $35,000 per year, you should target between $3,500 and $5,355 per year towards retirement savings. If you do this for 25-30 years, you should have a good, healthy supplemental income.
4) I purchased years under the old pension plan. Is that enough to off-set the need to invest? 5 years extra on your pension formula will probably not be enough to off-set the drop in income from your last working paycheck to your first pension paycheck. You probably would have been better off investing that money in a Roth IRA at the time given all of the additional costs it took to set up the financing for purchasing years. You may be able to get away with less aggressive investing, but I would want to still do some investing to supplement. Also remember that those of us that elected to take the .25% drop in our pension formula after 2012 (remember SB-1040?) will receive a lower pension regardless of whether or not we purchased years. If you elected to keep the 1.5% multiplier, you are paying more each check to end up with the same pension amount. Again, you probably want to be a DIY investor outside of the state pension system since chances are it'll only get worse before it gets better.
5) Which type of account should I use? Discussed here.
6) What should I be investing in? Index Mutual Funds inside of a tax-favored retirement account or taxable account. You simply earn what the market earns minus a very small fee each year. Index fund investors beat 70-80% of the entire investing community by saving on fees, taxes, commissions and the risk of picking a bad advisor or fund manager. With a Target Retirement or LifeStrategy fund, you buy thousands of stocks and bonds at .2% per year, your allocation is pre-set to avoid any sort of emotional market timing, and don't even need to rebalance! You do NOT need to purchase more than 5 funds to be diversified! Keep things simple with no more than 4-5 index funds in your investment portfolio (total stock, total bond, total international, maybe REITs and small cap value). If you have a Vanguard Brokerage IRA, you can also purchase ETF's, just like purchasing Vanguard ETF's through TD Ameritrade in an HSA investment account. Be sure to purchase broad, total market index ETF's. The ticker symbols for Total Stock, Total Bond and Total International are VTI, BND, and VXUS respectively and have the same expense ratio as their corresponding Admiral share mutual funds.
7) Why are you promoting Vanguard so much? Simple - lowest cost, and it's a company founded as a co-op (investors are the owners) with the main objective being to give the investors the best access to the market with the lowest possible costs. I don't work for Vanguard or gain anything from them. They also own the world's largest mutual fund - the Vanguard S&P 500 Index Fund. There are no annual commissions in a Vanguard IRA, and you can waive the $20 paper statement fee by receiving your quarterly statements by email. If you purchase shares of a Target Retirement or LifeStrategy fund, your expenses are no more than .18% and .16% respectively. Owning the Total Stock Market, Total Bond Market and Total International as individual funds with a minimum of $10,000 in each would lower the costs even more with Vanguard's Admiral shares (.05%, .08%, and .14% respectively). With the average mutual fund being around 10 times more expensive, this cost savings is huge. A $100,000 balance is only charged $100 per year at .1%, but is charged $1,000 per year with the more average expense ratio of 1%. Think about when you retire and have to start living off of your investments... I'd much rather be charged $100 per year per $100,000 invested versus $1,000! Lastly, all Vanguard funds are no-load, another great cost-savings bonus! There are other companies like Fidelity and Schwab that offer index funds at lower than average costs, but none are as low as Vanguard. Remember - costs are the only predictor of mutual fund performance.
8) Why should I invest in bonds if I'm young? Bond holdings should grow as we age, particularly as we near retirement. Bonds are not as necessary when you are younger (Target retirement accounts start at a 90/10 stock/bond allocation and gradually get more conservative). Bonds are investment "insurance" that protect capital earned from stocks. They also allow you to easily rebalance your account if stock holdings get too large so you can "lock in" the growth of your stocks before a sudden drop. Bonds also pay out a reliable stream of income in retirement and require less selling of investments to get your money out. You never want ALL stocks, but you also never want ALL bonds as stocks are what allow a portfolio to remain solvent in retirement. A general rule is to never own less than 25% stocks or less than 25% bonds (if you have a pension, you could consider holding fewer bonds).
Another good way to think about bonds (paraphrased from Jason Zweig, columnist with the Wall Street Journal) - Bonds are insurance against a worst-case scenario market environment. There have been instances of bonds beating stock returns over 15 and even 20 years. We simply do not know nor can we predict if you will ever be in one (remember, most people have a 50-70 year investment window). Best to own both - rarely does it make sense to own 100% of anything.
9) How much do I allocate to stock and bond funds? The old rule was to "own your age in bonds." This is too conservative for most people now, especially those teachers that will have a "guaranteed" pension check every month in retirement. I am going to do "Age in Bonds minus 15" - age 35 is 20% bonds, age 55 is 40% bonds. I plan to stay with a 50/50 stock/bond allocation in retirement. Your international stock fund should be between 20-30% of your total stock holdings. Anything else should be 10% or less - REITs, Small Cap Value (these two typically perform stronger than the S&P 500, but drop more sharply) or if you have the itch for single stocks or precious metals (which I don't). Changing bond allocation with age is a great idea because you aren't making decisions based on the news or based on emotions from market performance. Again, if you use Target Retirement or LifeStrategy, the rebalancing work is done for you!
10) Where does inflation fit into my retirement calculations? Inflation of the price of goods will erode your future purchasing power - so you need to invest at a rate that is greater than inflation to net real compound growth. Most retirement calculators allow you to enter the rate of inflation, as well as the rate of growth of your personal income. You should figure around 4%rate of inflation and I would not figure more than 1% rate of growth of my personal income. When figuring your retirement calculations, your pre-retirement investment returns should be around 8%, and your retirement returns will be around 7% with less stocks. Since inflation will continue to erode purchasing power of your nest egg for 20-30 years in retirement, you want to make sure you have a significant portion of your portfolio invested in stocks to maintain the nest egg. If you were hired before 2012, your pension includes a slight cost of living raise each year, but its only about 1%.
A very wise thing to start purchasing as you transition towards retirement is TIPS (Treasury Inflation Protected Securities). TIPS hedge against inflation (mostly correlated to the CPI and other measures of inflation) and have a somewhat low correlation to bonds (they "zig and zag" differently). TIPS can be a great diversifier and protect your fixed income portion of your portfolio from erosion due to inflation. TIPS can be purchased as an index fund from most fund families. A good rule of thumb is to change bond contributions to TIPS contributions in your retirement transition years until you have roughly 50% TIPS and 50% Bonds in the fixed income portion of your portfolio. I plan to have 50% stocks, 25% Bonds and 25% TIPS in my portfolio in retirement (TIPS and Bonds held 50/50 in fixed income).
11) Am I too old to do start investing? No one is too old to save, but of course, compound interest works the best if started early in life. This still should not deter one from saving for the future. All you've got is all you've got, so take advantage of the larger salary late in your teaching career and start putting it away into investments. An older teacher should not be as aggressive as a younger teacher with stock allocation, but the point for an older teacher is to save, save, save for tomorrow. You might consider working part-time and live off of your pension when you retire from teaching for 5-10 years while your investments compound. That little bit of time could mean a lot more money in your non-working years. Teachers over age 50 can also contribute $1,000 more ($2,000 if married filing jointly) to IRAs, 403(b)s, 401(k)s and those over 55 can contribute $1,000 more to their HSA.
12) Are there any good non-stock market investments to consider? Probably the only one I would consider is rental real estate. This; however, is very expensive, time-consuming, and could potentially be more of a hassle than it is worth. You should purchase properties 100%-down (pay cash) to virtually eliminate any risk if you don't have a renter. You should also purchase properties at an absolute rock-bottom bargain price for it to really be worth your investment. Do not be desperate for a renter (interview and select very carefully) - if you pay cash for each property you own, you have no need to rush to the next renter unless you feel very good about their ability to pay on time and not change their motorcycle's oil in the living room.
To alleviate the hassle of renters, insurance, property taxes, remodeling and everything else that is a part of rental real estate, you could consider purchasing REITs in your investment portfolio. REITs are Real Estate Investment Trusts that buy stocks in companies that closely follow the housing market (with a low correlation to the US stock market). This is a great alternative as REITs have historically made better returns than the US stock market (and also drop harder because they are more volitle), and they incur MUCH less stress and starting capital than buying a property. I am going to buy a REIT fund and will not let it exceed 10% of my total portfolio.
Every other "investment" out there is hazardous to your wealth... gold, commodities, futures, viaticales, tax schemes, etc.
Both an income source as well as a long-term investment could also be owning your own business. About 50% of all small businesses fail, so be sure you have a unique business that fills a specific need and be sure to have unbelievable marketing and customer service. NEVER borrow an SBA loan to start a business! Start small, grow slow, use retained earnings to expand, hire excellent people, and continually improve your "widget" and its function in the marketplace.
13) What steps do I take to get started? Go to DIY Investing and scroll to the bottom.
14) How do I learn more? Check out my Resources page for some great, trusted resources. Reading and learning more makes us wiser and more confident.
1) Is investing safe? The safer the investment, the lower the returns (and with annuities and cash value life insurance, higher costs). The investments outlined on this website though index funds are more risky than the proverbial cookie jar or mattress, yet much less risky than the roulette wheel in Vegas. Put another way - most of you that own a home are taking a very real risk - the loss of principle on the home. It is an educated and wise risk to invest in both the stock market as well as your house with the hope that both will go up in value as they have done so historically over a long period of time. The best way to hedge risk is through proper allocation of stocks and bonds and owning a diversified portfolio of index funds that buy the entire market over many years.
2) How much do I need to retire? Nobody really knows and everyone's situation is different. I suggest finding a retirement calculator or a simple compound interest calculator online to do some calculations. If you are receiving a pension, you will have some retirement income plus a little from Social Security. For me, that will be roughly half of my top salary in retirement, so I am going to invest to supplement at least some of the difference. To make your money last as long as you do, you will want to plan on a 3-4% withdrawal rate with about a 50/50 stock/bond allocation. If you wish to supplement $25,000 of income per year at a 4% withdrawal rate, you will need a nest egg of $625,000 (25,000/.04). To have $625,000 by retirement at an 8% rate of return, you will need to save about $21,000 per year for 15 years, $12,750 per year for 20 years, $8,000 per year for 25 years, and about $5,150 per year for 30 years. These are rough numbers, and no guarantee, but at least they are a start. If you won't need that much, then of course you won't need to save as aggressively. $100 per month started at age 25 through age 65 at 8% return will be over $335,000!
3) How much should I save now? Sort of answered in #2, but a good range is to save about 10-15% of your current household income towards retirement after you have all of your high interest (preferably all) debt paid off and have a 3-6 month emergency fund. If you make $35,000 per year, you should target between $3,500 and $5,355 per year towards retirement savings. If you do this for 25-30 years, you should have a good, healthy supplemental income.
4) I purchased years under the old pension plan. Is that enough to off-set the need to invest? 5 years extra on your pension formula will probably not be enough to off-set the drop in income from your last working paycheck to your first pension paycheck. You probably would have been better off investing that money in a Roth IRA at the time given all of the additional costs it took to set up the financing for purchasing years. You may be able to get away with less aggressive investing, but I would want to still do some investing to supplement. Also remember that those of us that elected to take the .25% drop in our pension formula after 2012 (remember SB-1040?) will receive a lower pension regardless of whether or not we purchased years. If you elected to keep the 1.5% multiplier, you are paying more each check to end up with the same pension amount. Again, you probably want to be a DIY investor outside of the state pension system since chances are it'll only get worse before it gets better.
5) Which type of account should I use? Discussed here.
6) What should I be investing in? Index Mutual Funds inside of a tax-favored retirement account or taxable account. You simply earn what the market earns minus a very small fee each year. Index fund investors beat 70-80% of the entire investing community by saving on fees, taxes, commissions and the risk of picking a bad advisor or fund manager. With a Target Retirement or LifeStrategy fund, you buy thousands of stocks and bonds at .2% per year, your allocation is pre-set to avoid any sort of emotional market timing, and don't even need to rebalance! You do NOT need to purchase more than 5 funds to be diversified! Keep things simple with no more than 4-5 index funds in your investment portfolio (total stock, total bond, total international, maybe REITs and small cap value). If you have a Vanguard Brokerage IRA, you can also purchase ETF's, just like purchasing Vanguard ETF's through TD Ameritrade in an HSA investment account. Be sure to purchase broad, total market index ETF's. The ticker symbols for Total Stock, Total Bond and Total International are VTI, BND, and VXUS respectively and have the same expense ratio as their corresponding Admiral share mutual funds.
7) Why are you promoting Vanguard so much? Simple - lowest cost, and it's a company founded as a co-op (investors are the owners) with the main objective being to give the investors the best access to the market with the lowest possible costs. I don't work for Vanguard or gain anything from them. They also own the world's largest mutual fund - the Vanguard S&P 500 Index Fund. There are no annual commissions in a Vanguard IRA, and you can waive the $20 paper statement fee by receiving your quarterly statements by email. If you purchase shares of a Target Retirement or LifeStrategy fund, your expenses are no more than .18% and .16% respectively. Owning the Total Stock Market, Total Bond Market and Total International as individual funds with a minimum of $10,000 in each would lower the costs even more with Vanguard's Admiral shares (.05%, .08%, and .14% respectively). With the average mutual fund being around 10 times more expensive, this cost savings is huge. A $100,000 balance is only charged $100 per year at .1%, but is charged $1,000 per year with the more average expense ratio of 1%. Think about when you retire and have to start living off of your investments... I'd much rather be charged $100 per year per $100,000 invested versus $1,000! Lastly, all Vanguard funds are no-load, another great cost-savings bonus! There are other companies like Fidelity and Schwab that offer index funds at lower than average costs, but none are as low as Vanguard. Remember - costs are the only predictor of mutual fund performance.
8) Why should I invest in bonds if I'm young? Bond holdings should grow as we age, particularly as we near retirement. Bonds are not as necessary when you are younger (Target retirement accounts start at a 90/10 stock/bond allocation and gradually get more conservative). Bonds are investment "insurance" that protect capital earned from stocks. They also allow you to easily rebalance your account if stock holdings get too large so you can "lock in" the growth of your stocks before a sudden drop. Bonds also pay out a reliable stream of income in retirement and require less selling of investments to get your money out. You never want ALL stocks, but you also never want ALL bonds as stocks are what allow a portfolio to remain solvent in retirement. A general rule is to never own less than 25% stocks or less than 25% bonds (if you have a pension, you could consider holding fewer bonds).
Another good way to think about bonds (paraphrased from Jason Zweig, columnist with the Wall Street Journal) - Bonds are insurance against a worst-case scenario market environment. There have been instances of bonds beating stock returns over 15 and even 20 years. We simply do not know nor can we predict if you will ever be in one (remember, most people have a 50-70 year investment window). Best to own both - rarely does it make sense to own 100% of anything.
9) How much do I allocate to stock and bond funds? The old rule was to "own your age in bonds." This is too conservative for most people now, especially those teachers that will have a "guaranteed" pension check every month in retirement. I am going to do "Age in Bonds minus 15" - age 35 is 20% bonds, age 55 is 40% bonds. I plan to stay with a 50/50 stock/bond allocation in retirement. Your international stock fund should be between 20-30% of your total stock holdings. Anything else should be 10% or less - REITs, Small Cap Value (these two typically perform stronger than the S&P 500, but drop more sharply) or if you have the itch for single stocks or precious metals (which I don't). Changing bond allocation with age is a great idea because you aren't making decisions based on the news or based on emotions from market performance. Again, if you use Target Retirement or LifeStrategy, the rebalancing work is done for you!
10) Where does inflation fit into my retirement calculations? Inflation of the price of goods will erode your future purchasing power - so you need to invest at a rate that is greater than inflation to net real compound growth. Most retirement calculators allow you to enter the rate of inflation, as well as the rate of growth of your personal income. You should figure around 4%rate of inflation and I would not figure more than 1% rate of growth of my personal income. When figuring your retirement calculations, your pre-retirement investment returns should be around 8%, and your retirement returns will be around 7% with less stocks. Since inflation will continue to erode purchasing power of your nest egg for 20-30 years in retirement, you want to make sure you have a significant portion of your portfolio invested in stocks to maintain the nest egg. If you were hired before 2012, your pension includes a slight cost of living raise each year, but its only about 1%.
A very wise thing to start purchasing as you transition towards retirement is TIPS (Treasury Inflation Protected Securities). TIPS hedge against inflation (mostly correlated to the CPI and other measures of inflation) and have a somewhat low correlation to bonds (they "zig and zag" differently). TIPS can be a great diversifier and protect your fixed income portion of your portfolio from erosion due to inflation. TIPS can be purchased as an index fund from most fund families. A good rule of thumb is to change bond contributions to TIPS contributions in your retirement transition years until you have roughly 50% TIPS and 50% Bonds in the fixed income portion of your portfolio. I plan to have 50% stocks, 25% Bonds and 25% TIPS in my portfolio in retirement (TIPS and Bonds held 50/50 in fixed income).
11) Am I too old to do start investing? No one is too old to save, but of course, compound interest works the best if started early in life. This still should not deter one from saving for the future. All you've got is all you've got, so take advantage of the larger salary late in your teaching career and start putting it away into investments. An older teacher should not be as aggressive as a younger teacher with stock allocation, but the point for an older teacher is to save, save, save for tomorrow. You might consider working part-time and live off of your pension when you retire from teaching for 5-10 years while your investments compound. That little bit of time could mean a lot more money in your non-working years. Teachers over age 50 can also contribute $1,000 more ($2,000 if married filing jointly) to IRAs, 403(b)s, 401(k)s and those over 55 can contribute $1,000 more to their HSA.
12) Are there any good non-stock market investments to consider? Probably the only one I would consider is rental real estate. This; however, is very expensive, time-consuming, and could potentially be more of a hassle than it is worth. You should purchase properties 100%-down (pay cash) to virtually eliminate any risk if you don't have a renter. You should also purchase properties at an absolute rock-bottom bargain price for it to really be worth your investment. Do not be desperate for a renter (interview and select very carefully) - if you pay cash for each property you own, you have no need to rush to the next renter unless you feel very good about their ability to pay on time and not change their motorcycle's oil in the living room.
To alleviate the hassle of renters, insurance, property taxes, remodeling and everything else that is a part of rental real estate, you could consider purchasing REITs in your investment portfolio. REITs are Real Estate Investment Trusts that buy stocks in companies that closely follow the housing market (with a low correlation to the US stock market). This is a great alternative as REITs have historically made better returns than the US stock market (and also drop harder because they are more volitle), and they incur MUCH less stress and starting capital than buying a property. I am going to buy a REIT fund and will not let it exceed 10% of my total portfolio.
Every other "investment" out there is hazardous to your wealth... gold, commodities, futures, viaticales, tax schemes, etc.
Both an income source as well as a long-term investment could also be owning your own business. About 50% of all small businesses fail, so be sure you have a unique business that fills a specific need and be sure to have unbelievable marketing and customer service. NEVER borrow an SBA loan to start a business! Start small, grow slow, use retained earnings to expand, hire excellent people, and continually improve your "widget" and its function in the marketplace.
13) What steps do I take to get started? Go to DIY Investing and scroll to the bottom.
14) How do I learn more? Check out my Resources page for some great, trusted resources. Reading and learning more makes us wiser and more confident.