The Retirement Gamble

I had another good night's sleep last night. Again, I took a couple of extra strength Tylenol before bed. Part of my ability to sleep is the fact that the only thing I have left is to finish up the planning for the family camp we call reunion. If I can find a teacher for the primaries, I will be finished. Melissa says she will take over once we get to the camp. We will see.

Bob came over last evening and we watched American Experience on TV. It was about Rockefeller and was very interesting. After he left I watched Frontline. It was an expose' of the handling of mutual funds by the investment companies. It seems there are many different "fees" charged to the 401ks that add up to 63% of the value by retirement time. Owners of the 401k invest 100% of the money, take 100% of the risk and end up with 36% of the money. The other 64% ends up being the "fees" over the years. The investigator learned that if he saved $200 a month for 50 years and accumulated $100,000, at retirement, he would only get $38,000 and the rest would have been paid in fees because of the compounding of the fees over the years.

He recommended that instead of mutual funds, the investor instead invest in a diversified portfolio of index funds and just hold them until retirement. Index funds do better then mutual funds. This story can be found at pbs.org/frontline and the story is called "The Retirement Gamble". I was glad I got out of mutual funds just before the crash of 2008.

More later...

A really market smart friend of mine shared this information:

Index funds are a form of mutual fund. They just don't pretend to "beat the market," rather they only buy and sell stocks and bonds to match the larger market they are emulating. Because of this, they can do it for much smaller fees. Vanguard and Fidelity are the leaders in this market.

You can still "pick your mix" here depending on how well you want to sleep at night. For instance, you can get an index fund that just invests in corporate bonds in the same proportions as the larger market. Here the earnings are smaller, but the swings in the value of your investment are less. Or you can invest in an "S&P 500" index fund that invests in corporate stocks in the same proportion as the relative value of the 500 biggest firms in the US. Here you get the rise (and fall) in the stock market plus any dividends. Most people are best off with some mix of the two approaches.

You can get more specific, for instance funds that invest in proportion in every sizable international company, or just US government bonds.

Historically, people who have had a reasonable mix of these index funds, always putting money in, have done pretty well over the long term, even considering the Bush recession, and the fees are about as low as you can get.

The problem is (1) getting money to put aside and (2) time - you have to start before you are 40.

More from my friend...

The problem is the "time value of money." For instance, if you can earn 7% on your investments (high, but possible), your money will double in 10 years, and double again (i.e., 4 times the original) in another 10 years, and double yet again in another ten years (8 times the original).

So an initial $10,000 becomes $20,000 in ten years, $40,000 in 20 years, and $80,000 in 30 years (plus additional money you put in over that period of time). So if you are 40 years old when you start saving, you have an extra "doubling" period than if you are 50.

Lower earnings rates take more time to double, but the concept is the same. Take the annual earnings rate you expect to earn and divide it into 72 to estimate the number of years it takes to double.

Although the market goes up and down, over a thirty year run, the ups have almost always exceeded the downs.

That said, if you are over 50, there are some ways to speed this up. People over 50 can put an extra amount of money tax-free into IRAs and 401K funds tax-free. Health savings accounts also allow you to put away money tax-free that you can accumulate and use after retirement to cover medical costs not covered by Medicare.

One way I have used in the past to pay off debt and build savings is the "$10 extra plan." Many of us, if pushed, can come up with an "extra" 10 bucks out of our budget if we REALLY need to.

So you start one month with $10 in the savings pot. The next month you up it to $20, the next month to $30, etc. Of course, at some point you can't find an "extra" $10, but the question is how far you can go before you hit that point. $100 per month? $200 per month?

The money can be used to go into savings or pay down credit cards and other debt. For debt reduction, a good strategy is to pay the minimum on most bills, but throw the "extra pot" against either the highest-interest debt or smallest-balance debt. When that one is paid off, you throw that monthly payment plus the "extra pot' at the next debt on your list, and so on until everything is paid off.