Retirement Hacks, DCA, Emergency Savings, Paying off Debt
In this post: I will give you an easy Retirement Hack, share my recent Investopedia Advisor Insights, and of course give you my Weekly Market Recap.
This is the Millennial Wealth Blog.
BEWARE! Retirement Hack Ahead!
If you have the option to contribute to a retirement plan through your employer, listen up. When we invest, there are many things that are not in our control that we have to, somewhat, leave to the cosmos. You can’t focus on things that you have no control over, like: market performance, politics, or even how well one of your peers is doing financially. Rather, focus on the things that are within your control. Making contributions to your retirement plan and how much you contribute is absolutely within your control. When you were first enrolled into your employer retirement plan, you were more than likely auto-enrolled with your contributions going into a target date fund that is based on your age and projected retirement date. A target date fund is typically a “fund of funds”, meaning, the fund’s portfolio is comprised of a handful of individual mutual funds or ETFs. Target date funds have certain benefits, like: professional management, rebalancing, and diversification. But, is putting your money into a target date fund right for you? If you have no interest in managing your own investments and the related costs or you just prefer to let someone else handle the “financial stuff,” then you are probably best served with a target date fund.
Congratulations!!! You can stop reading!!!
However, if you know a little bit about investing or maybe you are interested in managing your own investments and controlling the costs associated, please keep reading for a simple retirement hack that could save you thousands.
The average target date fund is 50+% more expensive than an average index fund or ETF due to active management. If you want to manage your own plan using ETFs or index funds, you can do well with the tools available in your plan. Having a well diversified portfolio is a very important piece to your long term success. With that in mind, one of the best retirement hacks is to look at what investments are held within the target date fund you would otherwise be investing in and replicate the mix as best as possible with your available investment options. Remember, target date funds are comprised of other mutual funds or ETFs, so you can find out what the portfolio is comprised of by looking at the fund Fact Sheet or in the Prospectus. Within these documents, you should find a section that outlines the composition of the Portfolio and tells you the percentage each investment makes of the overall target date fund. Pay attention to the asset class categories like: large cap stocks, short term bonds, emerging markets, and so on. Once you have identified the asset classes and percentages being used for each, then you can go back to your menu of investment options and find the alternatives. Your research is not quite done… Now, you will need to look at the Expense Ratios for each of the alternative investments. Make sure the investment options you are considering are less expensive than the expense ratio for the target date fund. If none of the options are cheaper, then you may be done with your research and you may be better off in the target date fund. If you have been able to identify some investments in each category with lower expense ratios, then you can continue the investment selection process. All that is left is to compare the performance of the viable options in each asset class. Compare each investment across all periods of time and pay particular attention to the 5 and 10 year periods to see how these funds have performed both pre and post 2008 financial crisis. Better performance in one investment may warrant paying a little more on the expense ratio, so don’t rely solely on the cost. Once you have selected the investments you will be using for each asset class, remember to allocate the percentages from the target date fund model to your new portfolio. Be sure to setup an automatic, annual rebalancing option to maintain your initial investment mix.
This all may seem like a lot of work, but let’s look at the potential savings. As reported by Interest.com, “The average target-date fund had a 0.73% expense ratio in 2015, according to a report by Morningstar, an outstanding source of independent research on mutual funds.” They go on to show a great example of the impact expense ratios can have over time. “Invest $100,000 for 25 years with an average annual return of 7% and an expense ratio of 0.73%, and you’ll end up with $451,903. Drop that expense ratio to 0.17%, and you’ll have $520,141 — an extra $68,283.” So, is spending the time and doing a little due diligence worth it?
To put the savings in perspective, the average annual household income in 2016 was about $57,000.
I am a Premier Advisor on Investopedia’s Advisor Insights, where I answer questions that are submitted by readers on topics ranging from the simple to the more complex. Here are a few recent favorites:
Should I transition my cash into mutual funds all at once?
I believe I have too much of my overall portfolio in cash (CDs), but I am hesitant to put all of it into mutual funds. How much cash reserve should I keep, and should I use dollar cost averaging when investing the rest, or put it all into the mutual funds at once?
This is a great question to consider! If you are thinking that you have too much cash, then you probably do. Unfortunately, there are a number of factors that will need to be looked at, like your life stage, your current financial position, and your time horizon for your financial goals. As far as cash reserves go, you should have enough liquid savings to cover 6 months of living expenses in case of an emergency. DCA or dollar cost averaging is a great strategy for systematic investing, but if you believe the market is going higher, you may end up averaging a higher cost to purchase shares than if you invested all at once. If you think the market is heading down, then DCA may be able to get you a lower average price. One thing to consider before making any investment is the total cost of ownership, fees and commissions. For more questions, talk to a fee-only financial planner.
What investment account should I use for emergency savings?
I’m looking for a safe, liquid savings account with a high APY to be used as an emergency savings fund. Ideally, my account would be secured, would allow a withdrawal in the event of an emergency and monthly deposits for the next 5 years, and would accrue the highest interest possible over my lifetime (next 50 years). What are some options for such an account?
Great question! Many people want to earn a better return on their emergency savings than they currently are, however, a basic savings or money market account is the most appropriate. Accounts that offer the kind of protection and access that you need for emergencies are typically going to produce a lower yield and that is OK. I tell people to look at online banks, like www.ally.com, they pay 1% APY and give you access by linking your primary checking or savings account to it. Again, the main goal is to have the money handy in case of emergency. If you can earn a little bit of interest, that is just icing on the cake!
Why is paying off debt always the biggest priority to advisors?
I have been an active follower of this site and have been around enough financial professionals in my time. One thing I always see and hear is advisors recommending that their clients pay off their debts above all else. Paying off debt seems to be advised over investing, saving, acquiring a loan, a home purchase, etc. Why is it that advisors and professionals are so firm on paying off debts before other options, is there a specific reason? I get that paying off one’s debts is crucial, but feel there are other options that should at least be considered as a primary goal for an individual’s finances. Are there any advisors who have a similar mindset to mine?
Good question. The primary reason advisors place such a high priority on debt repayment is because of the negative effects it has on building wealth. The greatest factors that help to build wealth are your income and your savings/ investment rate, but if you are paying a high rate of interest on debt, you are limiting your ability to grow wealth over time. Think about it this way; if you have $10,000 on a credit card at 20% APR, then your interest for one year is $2,000. Let’s say you had a great year in your investment account of $10,000 and earned 10%, you just made $1,000. If you had another $10,000 in savings, would you rather earn the 10% return in your investments or the 20% return by paying off your credit card? The reality of the matter is if you are not paying the interest on your debts, then you are essentially earning it. Just another way of looking at things!
This week in financial markets:
Major U.S. and European stock market indices surged early in the week on French presidential news. U.S. markets near all time highs with the Nasdaq setting new all time highs this week. Round 1 of the French Presidential Election brought optimism for the markets as Macron is polling to win big over Le Pen. Macron is a big proponent of the European Union and is seen as bringing some certainty to the stability of the EU. The polls and market reactions seem eerily similar to the polling of the U.S. election, in the lead up to what everyone thought would be a big win for Clinton in November. We will keep our eyes on May 7th when the French people decide their next president and the possibility of an upset. The Positive economic data keeps coming in. Unemployment claims reached a 17 year low. March existing home sales reached the highest levels since 2007. Companies continue reporting strong earnings for the quarter. Crude Oil little changed on the week still sitting below $50 a barrel to end the week. And the U.S. 10 year treasury yield is slightly higher at 2.28%.
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