Simple Secrets to Building Wealth: Retirement and Investing

Transcription

1 Simple Secrets to Building Wealth: Retirement and Investing Shahar January 23, 2016

2 What Do Saving for Retirement and Investing Mean To You? 1

3 You Already Invest! 2

4 Agenda Jan Planning for Success Owning Your Credit Insuring Your Future Taxing Your Income Today Saving for Future You Investing Success Wrap-Up 3

5 Setting Expectations Facts Insights Strategies 4

6 Trends Shift in Risk Future Rising

7 Foundational Concepts Present/Future Value Time Value of Money/ Power of Compounding Rule of 72 Illustrative Examples Which would you prefer? A) If I gave you $100 today B) If I promised to give $100 in 2 years? A) If I gave you $100 today B) Or if I gave you $200 tomorrow? A) If I gave you $100 today B) Or if I gave you $200 in 5 years?? 6

8 A Penny For Your Thoughts Day 1 Day 31 7

9 Time Value of Money Day Start Day 1 Start Day 2 Start Day 10 1 $0.01 $100-2 $0.02 $ $0.04 $ $0.08 $ $0.16 $ $0.32 $ $0.64 $ $1.28 $ $2.56 $ $5.12 $51,200 $2.56 $25,600 $100 $ $81.92 $ $5,242 $2,621 $ $167,772 $83,886 $ $2,684,354 $1,342,177 $5, $5,368,709 $2,684,354 $10, $10,737,418 $5,368,709 $20,971 Key Observations Exponential growth because of compounding ( power of compound interest ) If you start on Day 1, you end up with 2x more than if you start on Day 2 The last double matters most, but to get to it, you have to start early Delay of 10 years has drastic consequences (need to invest more to catch-up ) 8

10 The Magic of Compounding $12,000, $10,000, $8,000, $6,000, $4,000, $2,000, $- Day 1 Day 6 Day 11 Day 16 Day 21 Day 26 Day 31 Penny Day 1 Penny Day 2 Penny Day 10 The most powerful force in the universe is compound interest - Albert Einstein 9

11 The Story of Two Savers Parties for 10 years Opens a tax-deferred account earning 10%* and invests $2000/year for 30 years Total Contributions: $60,000 Age Annual Amount Total $2,000 $2, $2,000 $13, $2,000 $35, $2,000 $69, $2,000 $126, $2,000 $216, $2,000 $361,886 Opens a tax-deferred account earning 10%* and invests $2000/year for 10 years Then saves NOTHING for next 30 years Total Contributions: $20,000 Age Annual Amount Total 25 $2,000 $2, $2,000 $4, $2,000 $7, $2,000 $10, $2,000 $13, $2,000 $16, $2,000 $20, $2,000 $25, $2,000 $29, $2,000 $35, $38, $57, $92, $148, $239, $385, $620,643 10

12 The Consequences of Stiffing Morty Seinfeld Source:

13 Morty Seinfeld s Calculation How does $50 grow if interest rate is 5%? Year 0 $50.00 Year 1 $52.50 Year 2 $55.10 Year 3 $57.90 Year 10 $77.60 Year 52 $ (Note: These calculations use yearly compounding unlike the Seinfeld clip, which uses quarterly compounding)

14 Key Takeaway #1 START SAVING EARLY & SAVE CONSISTENTLY 13

15 Retirement Buckets Employer Options Other Options 401(k) Roth 401(k) 403(b) 457 Plan Individual Retirement Account (IRA) Roth IRA SEP IRA Solo 401(k) Bucket Clip Art

16 Where Do I Get a Bucket? Through your employer Direct through an investment firm or bank 15

17 Which Bucket(s) Should I Use? 401(k) vs. Roth 401(k) Set up through your Employer 401(k) allow you to invest pre-tax dollars (you pay taxes when you are older and withdraw) Benefit: Additional liquidity via upfront tax deductibility Set up through your Employer Roth allows you to invest post-tax dollars (your money grows and is later withdrawn tax-free Benefits: Potentially lower tax bill when you withdraw No penalty for withdrawal of contributions before age 59 16

18 401(k) Tax Benefits Income Tax Calculation $ Gross Income - Adjustments 401(k) contributions = Adjusted Gross Income - Deductions - Personal Exemptions = Taxable Income x Tax Rate = TAX LIABILITY Leftover Post-Tax Contributions Total Leftover Total In Retirement Account Roth 401(k) contributions 17

19 Comparing Tax Benefits Income Tax Calculation $ Gross Income - Adjustments = Adjusted Gross Income 401(k) $50,000 $10,000 $40,000 Roth 401(k) $50,000 $50,000 - Deductions - Personal Exemptions = Taxable Income x Tax Rate $40,000 15% $50,000 15% = TAX LIABILITY Leftover Post-Tax (Roth) Contribution Total Leftover Total In Retirement Account $6,000 $7,500 $34,000 $42,500 N/A $10,000 $34,000 $32,500 $10,000 $10,000 18

20 To Roth Or Not To Roth? Considerations Liquidity and other obligations Your income today vs. income in future Tax bracket today vs. tax bracket in retirement Overall tax brackets (not in your direct control) 19

21 Quick Overview of Plans Type Tax Advantage Eligibility Income Restrictions Contribution Limits 401(k) Roth 401(k) IRA Tax Deductible Contribution Tax-Free Growth Tax Deductible Contribution Employer Driven Employer Driven Roth IRA Tax-Free Growth Based on Income SEP IRA Tax Deductible Contribution N/A $18,000 N/A $18,000 N/A N/A $5,500 <$131,000 (filing single) $5,500 Yes N/A Lesser: $53,000 or 25% of income 20

22 How Much To Contribute? Considerations It depends... Your situation, other obligations Your values and priorities (reinforce importance of budgeting and planning upfront) Your liabilities (student loans, etc.) When you start Earlier you start, less you need to contribute each month 21

23 Employer Match Many companies will match a portion of what you put into your retirement account Example: 50% match up to 6% of your salary Your Salary = $50,000 You contribute 6% = $3,000 Employer contributes = $1,500 Total = $4,500 Guaranteed return on your investment 50% immediate and risk-free return in this case 22

24 Key Takeaway #2 CONTRIBUTE AT LEAST ENOUGH FOR FULL EMPLOYER MATCH 23

25 Key Takeaway #3 GOAL: 15% TOTAL CONTRIBUTION EACH YEAR (YOU + MATCH) 24

26 What Do I Put Into My Bucket? 25

27 CASE STUDY DISCUSSION 26

28 The Virtues of Planning Goals Behavior 27

29 Budgeting The Flossing of Financial Planning BUDGETING = AWARENESS 28

30 Case Study Takeaways Be prepared. Come in on day one with a financial plan in mind Enroll right away (time is your BFF) Take advantage of employer match (free money) Automate as much as possible Invest as % of your salary, not $ automates increases to contribution as your salary increases If you can t contribute 15% right away, automate increases to the % you are contributing Don t settle for employer default allocation of 3% Pick low cost funds (to be discussed next) Use target date funds if you are lost (to be discussed next) 29

31 Themes Saving vs. Investing Time Horizon Risk Level Diversification Alignment with Goals Alone or Getting Help?

32 Before You Start to Invest Build up an month emergency fund Pay off all your high-interest debt (e.g., credit cards) Maximize contribution to your retirement plan (especially if your employer matches) Save for other important [short-term] needs (e.g., down payment)

33 Defining Your Time Horizon Home Purchase Future Education Vacation and Travel Capital Preservation Paying Off Credit Card Debt Retirement Savings SHORT TERM MEDIUM TERM LONG TERM

34 Translating Risk into Specific Investment Choices CHECKINGS/ SAVINGS ACCOUNT MONEY MARKET BONDS STOCKS ( EQUITIES ) OTHER LOWER RISK HIGHER

35 Defining Asset Classes CHECKINGS/ SAVINGS ACCOUNT MONEY MARKET Principal contributions are protected from loss Guaranteed interest on money you put in Certificates of Deposit Short-term government loans BONDS STOCKS ( EQUITIES ) Debit issued by the government (federal, state, local) or by a corporation Receive interest income on regular frequency Ownership in a company Price appreciation and dividend payments OTHER Real Estate Commodities (Gold)

36 Examples You invest $1000 in stocks. In 1 Year +53% OR -27%

37 Example You invest $1000 in stocks. In 25 years OR +8% +11%

38 2016 is a good example... Dow Jones Index Jan 4, 2016: 17,148 Jan 20, 2016: 15,766 Down: (8.7%) Apple Stock Jan 4, 2016: $ Jan 20, 2016: $97.35 Down: (6.5%) Jan 4: $ Jan 21: $

39 Implications Source: MyMoneyBlog

40 Diversification Risk-management technique Mixes a wide variety of investments within a portfolio to minimize the impact that any one security will have on the overall performance of the portfolio Diversification essentially lowers the risk of your portfolio Spread your portfolio among multiple investment vehicles such as cash, stocks, bonds, mutual funds, and other vehicles Beware naïve diversification

41 Getting Tactical on Investing What should you invest in? How to build a portfolio and allocate money? How to choose an actual fund? What kinds of resources to use for more information?

42 What to invest in for medium and long-term? Mutual funds offer: Automatic diversification Convenience No need to research individual companies No need to pay for individual trades Lower costs Individual stocks: Riskier Require more attention Tangible ( I own part of Apple ) My Advice: Focus on mutual funds If you are inclined, leave a small portion for individual stocks, but treat it as play money

43 Where to open an account?

44 Building a Portfolio Individual Fund Characteristics Small vs. Large Value vs. Growth Domestic vs. International Equities vs. Bonds Fund Fees (Active vs. Passive)

45 Morningstar: Low Mutual Fund Fees Trump Our Star Ratings If there s anything in the whole world of mutual funds that you can take to the bank, it s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.

46 Like Flipping A Coin 2,862 2 Each time finding the same core truth: Very few funds achieved consistent and persistent outperformance. Furthermore, the data shows a likelihood for the bestperforming funds to become the worst-performing funds and vice versa. Sources:

47 Morningstar Analysis

48 Morningstar Analysis Investors would have substantially improved their odds of success by favoring inexpensive funds, as evidenced by the higher success-ratios of the lowest-cost funds in all but one category. On the flip side of the coin, investors choosing funds from the highest-cost quartile of their respective categories reduced their chances of success in all cases. The large-value category is the most poignant example. The lowest-cost funds in this segment had a success rate that was 28 percentage points higher than the category average over the trailing 10 years through December Meanwhile, their high-cost peers had a dismal success rate of just 19% during this same span. Odds of success generally decreased over longer time periods, with valueoriented funds being the notable exception. Value managers had a higher long-term success rate than other types of active funds. The lowest-cost mid-value funds enjoyed the greatest long-term success rate (68%) and the highest-cost mid-blend funds the lowest (5%).

49 Why Fees Matter $10,000 Investment Fund Expense Ratio Investment Value 33 bps ~$100,000 10% average annual return Over 25 years 169 bps ~$70,000 Sources:

50 Asset Allocation: Equity vs. Bonds Depends on time horizon Stocks have always outperformed in the long run Bonds help smooth out and reduce risk Some people say 110 your age or 120 minus your age If you re saving for other medium - long term goals, weighted more towards bonds Rule of thumb: closer you are to needing the money, more conservative you should be

51 Lifecycle ( Target Date ) Funds and Asset Allocation Far from retirement Closer to retirement Stocks Bonds

52 U.S. vs. International stocks The average US investor does not have enough exposure to international stocks Some reasons: People want to own what they know Country/political risk Currency risk Added cost We have demonstrated that domestic investors should allocate part of their portfolios to international securities and that a 20% allocation is a reasonable starting point. While adding an allocation of 20% to 40% has historically been beneficial, adding too much can increase portfolio risks without the commensurate benefits. We have demonstrated that international allocations exceeding 40% benefit a portfolio incrementally less, particularly as costs are accounted for. Although no absolute answer exists for all investors, it should be clear that an allocation range of 20% to 40% is reasonable given the historical benefits of diversification. Allocations closer to 40% may be suitable for those investors less concerned with the potential risks and higher costs of international equities. Allocations closer to 20% may be viewed as offering a greater balance among the benefits of diversification, the risks of currency volatility and higher correlations, investor preferences, and costs. - Vanguard Research

53 Sample Portfolio US Small 20% 15% Int l - Developed 10% Emerging Mkts 10% Other US Large 40%

54 There is no one right answer

55 How to actually pick a fund What to look at: Expenses, expenses, expenses Tenure of fund manager Stewardship company that puts the interests of shareholders first My recommendation for good place to start: Money 50 List ( /bestfunds/) Categorizes funds based on how you would use them Building Block Funds - all index funds to help build core portfolio Custom Funds One Decision Funds (i.e., lifecycle funds) Other resources: Morningstar ratings Reputable mutual fund companies Vanguard (16 of 50 on Money50 list are Vanguard funds) Fidelity T. Rowe Price Schwab Financial planner Credentials Pay structure Fiduciary duty Too good to be true, probably is Read WSJ article How to Choose a Financial Planner Other investing sites Motley Fool Seeking Alpha Books A Random Walk Down Wall Street Plenty others

56 The Market for Financial Advice

57 Auditing Financial Advice Passive Active ~7% ~50% 56

58 Recommendations If You Are Looking To Hire An Adviser Sample questions: What is your investing philosophy? How do you make money? Do you, when recommending investments, accept any compensation from any third party? Why or why not? Under which circumstances? How much do you estimate I would pay for your services the first year? What would make that number go up or down over time? May I see a sample account statement? (If you don t understand it, ask the adviser to explain it) Do you have a fiduciary duty to me?

59 Index Card Advice

60 My [Extra-Large] Index Card No one will care about your money more than you. Take charge of your money. Cultivate awareness of how you spend/save to ensure it aligns with your goals/values; find a system that enables you to live below your means Your most important asset is time; start saving early and aim for 15%/year Before you invest, make sure you save (emergency fund) KISS Focus on fees; buy index funds/etf s with the lowest fees Don t buy individual stocks. For every stock trade, there is a buyer and a seller. Each one thinks they made a smart move. Match your investments to your time horizon and risk tolerance Take advice with a grain of salt; only work with to fiduciaries Automate your finances as much as possible to leave time for the important things Money is a means to an end, not an end in itself. Don t forget about the journey and buy experiences that make you happy!

61 Wrap-Up Please complete Day 3 survey your feedback is important and influential! We would very much appreciate additional on the record testimonials This helps us report back to the university and market the course to your peers next year If you are willing, please fill out the sheet below and we will contact you OR Send an directly to Laura (laura_buso@harvard.edu) with your thoughts 60

62 Questions I ll be here afterwards to answer in person me: sziv50@gmail.com 61

63 Appendix 62

64 Automate Your Finances VS. 63

65 What and How to Automate? Emergency fund/savings Retirement contributions What Investment contributions Bills/Debt Payments (e.g., student loans, credit cards) Credit report pulls Remember: Companies like to automate too! How Employer s payroll/direct deposit system Bank/Credit Union processes Bill/Debt Payment processes Calendar reminders 64

66 Anchoring Trap Is population of Turkey greater than XX million? What s your best estimate of Turkey s population? 65

67 Results Is the population of Turkey.... Version A: greater than 5 million Version B: less than 65 million What is your best estimate of Turkey s population? Difference: My favorite response: Is the population greater than 5 million: What is your best estimate of the population? NO 10 Million 66

68 Do Defaults Save Lives? 67

69 Auto-Enrollment and Auto-Escalation 68

70 Paradox of Choice 69

71 Tradeoffs: Student Loan Payback vs. Retirement Savings Example Interest Rate Expected Rate of Return? VS.? Student Loan Interest Rate Up to Employer Match 6.8% VS. 100% Student Loan Interest Rate Above Employer Match 6.8% VS. 6 7% 70

72 Hierarchy of Needs Illustrative Other Travel Education Down Payment Health Savings Retirement - Additional Emergency Fund High Interest Debt Retirement Employer Match 71