Successful Investing Strategies for Millennials

We have all heard how important it is to start saving for retirement at a young age; but what exactly does that mean? A lot of young working people will sock money away in a savings account and think they are doing the right thing. While having cash for a rainy day/unexpected life event is very important, it is not at all how to save for retirement or save for a big purchase (i.e. down payment on a mortgage/new car). The secret behind it all is something called “compounding interest”. Compounding interest is something that happens over the course of many years and is hands down the best strategy to obtaining financial freedom.

For starters, it is important to understand what kind of account you are funding. Ideally, funding both a qualified account and non-qualified account is important. Qualified accounts are tax-advantaged retirement accounts such as Traditional IRAs, Roth IRAs, and 401ks. The beauty about these accounts is that they can grow either tax-deferred (such as a Traditional IRA) or tax-exempt (i.e. Roth IRA), however they cannot be tapped until a later age without penalty. Qualified accounts also come with contribution limits so one cannot put in an indefinite amount. Although you will pay tax on earnings upon sale of investments within non-qualified accounts, the good news is that the funds are available for withdrawal at any time with no age restriction.

We understand young workers may not be able to fund both kinds of accounts early in their careers, therefore, we recommend funding the qualified accounts (retirement) first, followed by the taxable, non-retirement accounts.

Click here to learn a little more about Roth and Traditional IRA’s (qualified/retirement accounts).

The next step is to determine what kind of asset allocation aligns with your ‘Risk Tolerance Level’. We recommend consulting an investment expert, like DWM, to help determine your risk level profile (e.g. defensive, conservative, balanced, moderate, or aggressive) and the funds you should be invested in. Assuming your risk tolerance lands you in a “balanced” portfolio, you should expect a targeted long term rate of return of 6 to 8% per year. This may not sound like an enormous annual rate of return, but after compounding interest over a long investment time horizon, one is capable of achieving impressive portfolio numbers.

Now for the magic of compounding interest, what it can mean for your future, and why it is so important to start early for young workers. The best way to explain this is through an example:

If you contribute $5,500 to a Roth IRA (the max a Roth allows each year) starting at 22 years old and average 7% return per year until retirement at age 65, the $236,500 total contribution will turn into $1,566,121.

Compare that to socking away $5,500 into the same type of account, invested in the same exact funds, starting at age 40: Your account will grow to $372,220. This is still great and much better than not investing at all, but it would be a lot nicer to grow an account to over 1.5 million dollars versus less than 0.4 million dollars going into retirement.

An accepted estimate in the financial planning world is something called “The Rule of 72”. This is a quick and simple math equation that estimates how many years it will take to double an investment, given a certain annual rate of return. If we assume a 7% rate of return, we would divide 72 by 7 to come to a final answer of 10.24. So, with an annual return of 7%, it will take you a little over 10 years to double an investment. Therefore, a 25 year-old has the potential to double his/her invested money every 10 or so years from your early 20’s until retirement (4x over).

This means one would need to more than quintuple your annual income if you wait until age 40 vs. starting at 22 to make up for not putting away the $5,500 the 18 years prior (~$1.25 million) you technically missed out on.

Click here to see what amount you can achieve if you started putting $5,500 away today.

Another big misconception with saving young is “maxing out a 401(k)”. Many young workers will say they are maxing out their 401(k). However, simply putting away the 3-4% a company matches is not at all maxing out a 401(k), in fact, it is barely scratching the surface. As of 2017, the maximum employee contribution, per year to a 401(k), is $18,000- this is maxing out a 401(k). Let’s say a 25 year old makes $50,000 per year and is contributing 4% to his/her 401(k) that the company is matching. This 4% is only $2,000 per year and the match only becomes yours after it vests. It is important to understand your companies vesting schedule because in some cases it can take six years or more for that to actually be considered your money.

Another important step to saving/investing correctly is analyzing the investment menu within your 401(k). This involves studying the funds offered within a 401(k) and identifying an appropriate asset allocation target for yourself in-line with your risk tolerance. It is also important to look at the underlying fees within the funds of the 401(k). If you are in a large cap equity fund charging 70 basis points but there is another large cap fund that charges only 9 basis points, it can make a big difference over 20-30 years. Here at DWM, we do a 401(k) analysis for all clients because we understand the importance a few basis points can have on an individual and their family over the course of a lifetime.

We have all heard our millennial generation and future generations will never be able to retire because of different theories on social security and how rare pensions are today. This could not be further from the truth. We simply need to take our savings just as seriously as our expenses and we may be capable of not only retiring, but comfortably retiring and being able to leave a legacy for future generations. While a lot of millennials believe they are going to invent the next pet rock and become overnight millionaires, it might be a good idea to start saving the correct way because slow and steady does indeed win the race. 

Strategies to Stretch Your Nest Egg

cash as nest for eggsOne of the most emailed NYT articles in the last week has been Tara Siegel Bernard’s “6 Strategies to Extend Savings Without Working Longer.” We thought today we would take a look at her six suggestions and critique them.

Ms. Bernard’s suggestions:

Practice Living on Less. This is a great strategy to consider. Over the years, we’ve reviewed the finances of hundreds of clients and prospects. It’s amazing to see how little some spend, even when they could spend more. Of course, then there are others that spend vast sums of money and still seem to need more money to be happy. And, of course, there are lots of Goldilocks situations, whose spending seems “just right,” providing all they need to do all the things they want to do in a cost efficient manner, without wasting money.

Maximize Social Security. This is another very important strategy. Many couples are scheduled to receive over $1 million in social security benefits in their lifetimes. And, handled properly, they might increase that by 15 to 20%. Social security is a fairly complicated maze of rules. We use a software to investigate scenarios for clients to illustrate the impact of planning strategies. Of course, the 800 pound gorilla in the room is when the social security system will change. It’s a hot current topic, even in Presidential debates. Some proposals would raise retirement age, suspend COLAs, and limit or eliminate social security for those with retirement income and assets above a certain amount. Therefore, the analysis of maximizing social security needs to be reviewed while looking at possible changes to social security potentially impacting couples with significant anticipated retirement income and/or assets.

Reduce Taxes. Another very important strategy. Like the first two, this just doesn’t happen; it requires planning. Again, there are lots of different planning ideas if income declines at retirement time. These may include possible Roth conversions, deductible rental losses, starting a consulting business and making sure your investments are allocated tax-efficiently. It’s a good idea to review your income taxes at least twice a year. Once early in the year when your returns are being prepared, and again in the late summer or early fall. Your wealth manager may have an idea or two for you and/or your CPA to consider at both times of year.

Get a Reverse Mortgage. Home equity is a huge asset for many. And, more and more people are “aging in place.” We’ve been modeling “reverse mortgages” for clients using our MoneyGuidePro software for years. One approach is a standby reverse mortgage, where borrowers obtain a line of credit to be used as needed. A reverse mortgage doesn’t have to be paid back until the borrower dies or moves out of the house.

Buy an Annuity. We don’t agree with Ms. Bernard on this one. You’ve read our blogs on annuities in the past. Annuities really appeal to folks for their simplicity and the idea that they get a “payment for life.” Here’s the problem: an annuity locks up your money and pretty much pays you back your principal plus a tiny (usually 2% or less per year) return. Can you imagine what happens if interest rates rise to double digits (like 35 years ago) and all of your money is now coming back at low fixed rates and you can’t get out of your contract? Here’s a better solution: build your own “liquid” annuity by creating a diversified investment portfolio from which you draw monthly amounts. And, this can be done without the huge commissions, costs and inflexibility of an annuity.

Radically Downsize. We don’t see this as an appropriate strategy for our clients. In Ms. Bernard’s example, she has a couple selling their farm in Essex, NY and moving to the Philippines, where they could afford to live on $2,000 a month. While their monthly overhead has been reduced, in my opinion, they are incurring a huge “cost” of moving away from family and friends at a very important time of life. If Ms. Bernard had eliminated the word “radically,” I would have agreed with her that this is a strategy to consider. Many couples should consider downsizing or right-sizing in retirement. Equity developed from this process could provide funding for other goals they might want.

Overall, I do commend the article by Ms. Bernard. She outlined some really good strategies and we’ve been recommending for decades. What she doesn’t suggest though is a strategy perhaps more important than her six:

Start your Long-Term Planning Early. Start in your 20s and early 30s to identify your needs, wants and wishes. Calculate what you might need over your lifetime. Develop a plan to get you there. Start saving, even if it’s a small amount, early on. And monitor your plan at least annually and update as you go. Don’t wait until you are on the brink of retirement to ask: “How do I stretch my nest egg?” Rather, as a young person, ask: “How soon can I achieve financial independence?” If you can, work with a wealth manager to help you objectively do this. At DWM, long-term planning is one of our major strengths and passions, for clients of all ages.

So Many Numbers: Which Ones Are Important?

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

Now, knowing a little more about our number system and with numbers seemingly everywhere, where do we focus our attention? Here are five key numbers that have a big impact on your ability to meet your financial goals:

Percentage of your paycheck that goes to savings/investments. This may be the most important decision in your life. By saving early, you can have a portion of earnings grow in a compound fashion for decades. Furthermore, by “paying yourself” off the top, you limit the amount available for everyday living expenses during your working years. This discipline helps you in two major ways to obtaining early financial independence- first, by creating the fund for “retirement” and second, by reducing the expenses you will likely have during “retirement.” BTW- there is no magic percentage. Everyone’s circumstances are different. Consider an amount of 10-20% of your gross pay.

Your Annual Living Expenses. Monitor your expenses for last year and group them in three categories- needs, wants and wishes. Review the data from a long-term perspective. Spending a considerable amount now on wants and wishes will obviously reduce the amount available in future years. It’s all about choices and accountability. For the most part, you alone can determine and control your level of expenses.

The Asset Allocation of Your Portfolio. This is one of your most important investment decisions. Based upon your risk profile you need to determine how best to split up your investment funds between stocks, bonds and alternatives (which can include real estate). Studies show that 90% of your investment returns are the result of your asset allocation.

The Net Returns on Your Portfolio. Research shows that fees really matter. A $1,000,000 portfolio that earns 5% net per year will grow to $4.3 million in 30 years. The same portfolio that earns 4% net per year will grow to $3.2MM. The difference is $1.1 million- a 26% reduction. Over long periods, loads, commissions, high operating expenses and management fees can be a significant drag on wealth creation. Low cost passive investments are best for stocks and bonds. Make sure you understand and monitor all fees charged to your portfolio. Make sure you are getting real value for all the fees. And certainly, know what your net returns have been, are expected to be and how they compare to the appropriate benchmarks.

Your Effective (average) and Marginal Tax Rate. Tax costs on earnings, investment returns and other income can be huge, particularly as a result of the increases caused by the Affordable Care Act. You and your advisors should know your tax rates and use them as a key factor in decision making and investment strategy. Furthermore, proactive planning designed to minimize taxes is a must for you and your advisors.

Over the last 45 years, I have worked with clients of all ages, income levels and circumstances. A common thread among those who have achieved or are achieving their financial goals is that they all knew of and monitored these five key numbers regularly, making adjustments as appropriate. And, of course, they use objective, proactive, value driven advisors like DWM to help them as well.

Why not make it a New Year’s Resolution to know and monitor these five key numbers for your financial future? It could change your life.