Perspective from the Checkout Line

As I stood in line this past Sunday at Wegmans, amidst the usual sea of candy bars, energy shots, and chewing gum, I was faced with a dilemma.  As I stared down my favorite pack of gum, I couldn’t decide whether to buy or leave it alone.  Luckily, my phone’s calculator helped my answer the question as I waited for those in front of me to cash out.  Allow me to explain.

Our good friends at the IRS recently raised the contribution limit for 401(k) retirement plans by an additional $500 starting in 2013.  This means the amount you are now able to save for retirement during this coming year is $17,500.  Those over the age of 50 have an even sweeter deal, as the “catch-up” contribution of $5,500 that you’re allowed brings your maximum contribution to $23,000.

Now, I am not naïve enough to think that money grows on trees and we‘re all contributing the maximum amount right now and can easily add another $500 to that total.  In fact, according to this CBS article, just 5% of participants nationwide are making the maximum contributions to their retirement accounts.  That is understandable when you look at the cost of daycare, college tuition, and a single gallon of gasoline.

But consider this.  Over the course of a year, $500 breaks down to approximately $1.40 each day.  If you take that $500 and put it towards your retirement in each of the next 20 years, assuming a 5% yearly return, the extra $10,000 that you’ve contributed will be worth nearly $17,000.

Now I can answer the question – do I really need the gum?

Chuck Wade

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #1: Give Yourself a Raise

Sure everyone would if they could, but an increase in salary is not what I’m talking about here.  What I’m suggesting is the most important thing you can do to build your retirement savings: give your retirement contributions a raise.  Once you get in a 401(k) or 403(b) and establish your contribution, you can go about the rest of your life and not have to think too much about your plan.  Some people think about increasing their contribution, but years can go by before you get to it.  After all, there’s more to life than spending every waking moment thinking about your investments (except for me).

So the raise idea is this: set a date every year to increase your percentage.  It could be your birthday, your anniversary with your employer, maybe Arbor Day.  On that day every year, bump up your contribution by 1%.  If you started with, say, 2%, then in 4 years you will have tripled your rate of savings.  You won’t miss the extra few bucks each year, and your account balance will grow much faster.  It may be the only case where you can give yourself a raise. If you are serious about growing your net worth, don’t ignore this rule.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #2: Percents, Not Dollars!

We have covered the first question for plan participants: How much?  How much should you contribute, how much will keep you comfortable in retirement, how much can you afford today?   If you decide what you can afford and that’s your contribution, it’s a perfectly reasonable approach (but don’t forget this rule when deciding).  But once you have decided that a contribution of $5 or $50 or $500 per paycheck is the right amount, you have an important step to take.

Convert that dollar amount to a percentage.  If your gross pay in an average period is, say, $1000, then a contribution of $50 should be noted as 5%.  There is on the surface no difference, but what about when you get a raise or bonus? What if you work overtime? Your pay rises but your contribution does not, unless you use a percentage. The flip side is also true: if you earn less in a period, a percentage-based contribution will be smaller, so your net pay will not be reduced out of proportion.  But there is also a life issue that might not seem obvious.  You have a life to live, a job, family obligations; stuff to do.  Let’s face it: once you get your 401(k) or 403(b) set up, making changes will just not land very high up on your “to do” list.  Sometimes years can slip by before you get around to a review (that can be good).  But if your income grows and your contribution does not, you’ll fall behind in seeing your account grow to where you need it to be.  So set up your contribution as a percentage and you can get back to enjoying life.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #3: Money in Your Pocket

The first thing you do when signing up for your employer’s 401(k) or 403(b)  is decide how much to put in out of every paycheck.  You don’t need my advice for that, of course; it’s a function of how much you can afford.  But once you decide on the amount, on how much you’re willing to save toward your future, that’s where this bit of advice comes in.

You already know there is a tax savings from contributing to your plan. Here’s how that works: every dollar you contribute is subtracted from your pay before Federal & State withholding taxes are calculated.  Since your contribution escapes income tax, the amount of tax withheld from your pay is less, thus your net pay rises a bit. Put another way, for every dollar you put in your plan, your take-home pay will only drop by 75 or 80 cents.   It really means that you’re putting money in your plan that otherwise would have gone to taxes, but it also means that you need to do a little simple math to grow your savings faster than the average person. 

To keep the math at its simplest do this: settle on how much you can afford to contribute and divide it by .8 to arrive at a slightly larger amount, which is what you should contribute.  If you decide that $25 is what you can afford, dividing that by .8 gives you $31.25.  The effect is to allow you to contribute the $31.25 but see your net pay reduced by only about $25.  The extra six bucks is what would otherwise go for taxes – you are legally keeping the Fed & State share and investing it!  That’s money in your pocket.

The numbers in this example are approximate, always consult your advisor or sharpen your pencil to get a result specific to your circumstances.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #4: Cash is Trash

In most 401(k) and 403(b) plans, money market and short-term bond funds are among the most popular investment choices.  That is especially true recently, when fear and panic among investors sent many scrambling for something more stable than the stock market. With the smoke cleared from last year’s financial crisis, retirement plan investors are noticing something they always knew but had not cared about last year: you will make nothing (or close to nothing) on money market and short-term bond funds.

Are those funds really safer? That depends on how you measure safety.  If having too little money to live on in retirement would make you feel uneasy, then you should be uneasy about having a money market fund in your retirement plan.  With rates close to zero, you’ll never see your account grow to the point where it will give you a comfortable retirement. 

There is a cost to everything in life; you get what you pay for.  With a money market fund, what are your getting?  You’re getting stability and liquidity – you can pull your money out whenever you wish.  And what does it cost? You get little or no return – and that cumulative “cost” over time can be enormous.  Unless you’re on the edge of retirement, you’re not going to be drawing money out of your 401(k), so accepting the cost of a low return means you’re paying for something – liquidity – that you are not getting.

Keep your eyes on the prize: a healthy account balance in retirement.  You’ll only get there if you have robust investment returns. And when it comes to returns over time, cash is trash. 

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #5: Stay Away

Back when I started contributing to a 401(k), first class postage cost 20 cents.  It was the year Apple introduced the Macintosh.  Ronald Reagan was re-elected, and the LA Raiders won Super Bowl XVIII.  Hair was big back then.  The internet did not exist, and you could check the value of your account 4 times a year when your statement arrived.  If you wondered how you were doing between statements, some, not many, plans offered telephone access to your accounts.

In those bygone days we didn’t make many changes. But by the turn of the 21^st century web access became common.  Also common is that many people check their accounts frequently – some folks multiple times daily.  I know that because I get reports from the plan recordkeepers with whom we do business and one of the metrics is frequency of web access. Some people seem to believe that by checking regularly they can monitor, adjust, and improve their performance. I have one suggestion about that:

Don’t.

Don’t look at your account so often, don’t make frequent changes to your fund mix, don’t drive yourself crazy.  Looking at your account every day is like driving while looking out your side window.  Don’t constantly lift the lid to check the soup. Select your ingredients carefully and let them simmer.  If you have a crystal ball then check your accounts all the time. If not – stay away.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule # 7: Do the Opposite

Working my way up we have touched on my rules #10, #9, and #8, all of which are very basic “starter” rules for getting involved with your 401(k) or 403(b) plan at work. Today’s rule assumes you are a plan participant and have been contributing for a while. At some point you start to think about what if any adjustments you should make to the investments in their plan. After all, you get your statement or go online, you see the performance of your funds and of all of the available choices and there is a temptation to move some money into the funds that have done best over the last quarter or year. We see funds flow into growth funds during strong bull markets and into cash in bear markets. It’ human nature – you see a fund with a great quarter or even better, a great year or two. Maybe one (or more) of the funds you’re in isn’t doing so well. So you switch.

Eight times out of ten you will have been better off not making that switch. The hot fund has turned cold (in some cases stone cold). So should you never make a change? My rule #8, Better Than a Crystal Ball, suggests using just 4 funds in your plan. Once you have the 4, simply manage them by rebalancing once a year. Bring all of the percentages back in line, swapping a little out of the fund or funds that have done the best and into the laggards so that you are back to 25% each. But wait – no one wants to put money into the laggard. Everyone wants to put more in the best performer. By doing as I suggest you will be going against the flow, being counterintuitive, contrarian. You don’t make money in the financial markets by following the herd. You make it by doing the opposite.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #8: Better Than a Crystal Ball

I don’t have a crystal ball.  And if I did I’m not sure I would know how to use it.  It seems like having a crystal ball would come in handy to figure out what investments to choose in your 401(k) or 403(b).  You look at a list of funds or go online and see a bunch of choices, maybe read about a few, look at the numbers, make your choice.  Some folks ask for advice in choosing and we are always happy to consult. I frequently meet with clients seeking my advice and find that their account balance is invested like this: 5% This Fund, 20% That Fund, 15% Other Fund, 40% Big Fund, 20% Obscure Fund.  Many investment gurus will use their crystal ball to tell you what percent to put in any given fund.  Unless no one really has a crystal ball. How then do the gurus come up with their percentages?  Beats me.  Since there is no way to know which fund will do best, why fuss over 11% here and 23% there? 

Think about this: when you get your statement what’s the main thing you want to know? It’s this: How am I doing? That’s what everyone wants to know.  When your assets are split into many odd pieces, how can you figure it out? And do you really want to spend the time trying?  My advice: keep it simple. When investing in your retirement plan choose just 4 funds and put 25% in each.  Then whenever you get a statement you will know how you’re doing. You’ll know which of your funds is the best, which is the worst, and by how much. Decision making will be much easier – no calculator needed, no guessing whether you should have 17% in this or 42% in that. You can rebalance once a year, getting the 25% each back in line.  Meanwhile, if you can get a crystal ball, go ahead and use it.  But for my money, a fixed percentage is better than a crystal ball.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Ground Rule #10: Start

Today I’ll start the countdown of my Ten Ground Rules for 401(k)/403(b) Success. These are common sense guidelines I have refined from nearly three decades of talking with clients and observing their results within employer-sponsored retirement plans.

The first rule seems so simple and obvious as to be unnecessary: Start.  Get started. Enroll in whatever plan your employer makes available.  It’s surprising how many people delay their participation in retirement plans. There are always reasons: you’re new on the job and not familiar with the plan, or you feel you can’t afford to, or you mean to get involved but just hadn’t gotten around to it.  Would you fail to sign up for your employer’s health insurance benefit? Would you not take any vacation because you hadn’t gotten around to understanding the time-off rules? Of course not.  Building your personal net worth is just as important, it’s just not as immediate.  So focus on your employer’s plan, ask for guidance if you need it, and enroll.

Some people get frustrated by articles stuffed with numbers showing how much money you need to save to retire.  That frustration can cause them to avoid participating altogether and make the goal even harder to reach.  Don’t worry about goals, not yet.  Just get in your plan and start contributing. Without a start, the rest of my rules won’t do you any good.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).

Early Distributions: Avoid when Possible

The one thing you can expect through the course of your life is unexpected expenses. Some turn out to be minor in scope but others can be quite damaging to the checkbook. A roof that needs to be replaced; a child that needs braces but doesn’t have orthodontia; a car transmission that decides it has worked for long enough… the list goes on and on.

When these things arise, the first question is often “How am I going to pay for this?” and while I don’t have the specific answer for you and your situation, I can tell you what to avoid: early distributions from your 401k or IRA. Your statement arrives every three months with an ever-changing account value, but what you will receive if you attempt to draw out that money is far less than the printed number.

Say you have built up $10,000 in a 401k at work. Surely you planned to use this to fund your retirement, but you weren’t expecting your roof to start leaking and buckets of water to start falling onto your carpet. You get a repair estimate and low and behold it comes to $10,000…so you take the cash from your 401k and it seems like a wash: you lose your retirement savings but at least you have the full $10,000 for the roof, right? Not really. When you drew that money out of the account it became taxable income. If you are (for example) in the 25% tax bracket, right off the bat you’re working with only $7,500. But you’re not done yet. The IRS penalty is 10% for withdrawals for people under the age of 55 in a 401k or 59 ½ in an IRA.

So that $10,000 shown at the bottom of your statement is actually more like $6,500 after Uncle Sam takes his cut and then hits you with a penalty for taking your own money. No one likes taking out loans, particularly lately, but odds are the interest rate won’t be 35%. Some 401k’s offer loan provisions so you can ‘borrow’ the money from your account as long as you promise to pay it back. As a last resort, you are able to take the money from your retirement savings (after all, no one wants to have water dripping on their face while they try to sleep!). Just beware of the implications of doing so. If there is another way to pay for it, odds are it may be the better way.

Steve Hicks

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp.  The author’s opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).