What Kind of Return Can I Get From Stocks and Mutual Funds?


Yearly Returns for the Vanguard Mid-Cap and Small-Cap Indices, from Prospectus

Yearly Returns for the Vanguard Mid-Cap and Small-Cap Indices, from Prospectus

Certainly you can get much better returns from stocks and mutual funds than you can from bank accounts.  Over long periods of time stocks have averaged 12-15%, compared to 6-10% for bonds and maybe 1-3% for bank assets like CDs and money market funds.  The reason is that you are taking a bigger risk by investing in stocks than you are in the bank, so stocks are priced so that when things do work out you make enough to justify the risk that you took.  After all, if I asked you to loan me a thousand and you knew that there was a 10% chance I would not pay you back at all, and maybe a 35% chance that I would just pay you back the $1000 after a few years without any interest, you wouldn’t loan the money to me unless you knew there was a chance I might pay you back $1500 in a year or two.  That way, if you had enough people like me and you made enough loans, you could be assured of making enough from the ones who paid you the $1500 to make up for the few that just kept your $1000.  You’d need to make enough from those who did pay you interest to counterbalance even for the cases where you just get your money back and no interest, since otherwise you’d be better off just putting your money in the bank and earning 2% than to loan to those people and get no return.  The trouble is, you don’t know who is who at the start.

And that’s something you really need to understand when looking at returns from stocks and even bonds.  The returns stated aren’t regular, consistent, or predictable.  In any given year, stocks may be way up or way down.  You can’t plug 12% into a compound interest calculator and predict what your account balance will be in 1, 3, or 5 years.  To see this, look at the table below that gives the annual returns for the Vanguard Small-Cap and Mid-Cap Index Fund ETF Shares (taken from the Vanguard Prospectus) for the period from 2005 through 2013:

 

Total Return
Year Small-Cap Mid-Cap
2005 7.53% 14.03%
2006 15.79% 13.69%
2007 1.27% 6.14%
2008 -35.99% -41.79%
2009 36.31% 40.49%
2010 27.89% 25.57%
2011 -2.68% -1.96%
2012 18.22% 15.98%
2013 37.80% 35.15%

A graph of these total return numbers are shown at the start of this post.

Presented below are the values of an initial investment in the Small-Cap and Mid-Cap index of $10,000 in 2004, the total return for the full, 9-year period, and the annualized return for that 9-year period.

Value of $10,000 Invested in 2004
Year Small-Cap Mid-Cap
2005 $10,753 $11,403
2006 $12,451 $12,964
2007 $12,609 $13,760
2008 $8,071 $8,010
2009 $11,002 $11,253
2010 $14,070 $14,130
2011 $13,693 $13,853
2012 $16,188 $16,067
2013 $22,307 $21,715
Total Return 223.07% 217.15%
Ann Return 9.32% 9.00%

Note that over the 9-year period there were some very good years and some very bad years.  If you had invested in 2004, but then needed the money in 2008 and sold the shares of your fund to raise the cash, you would have actually lost a couple of thousand dollars.  You would have done even worse if you had invested in 2007, losing 40% of your investment over the next year.  On the other hand, if you had invested after the drop in 2008, you would have done spectacularly well, increasing your portfolio value by more than 150 % in the next five years.

In total, you made an annualized rate of 9.32% in the Small-Cap fund and 9% even in the Mid-Cap fund, meaning that you would have ended up with the same amount of money at the end of the period investing in these index funds as you would have received if you had put the money in a fixed income security paying a straight rate of 9.32% and 9% per year, respectively.  The way you earned that return, however, was very unpredictable and truly a wild ride.  This period of time, with the housing bubble burst causing a large decline in stocks in 2008 was certainly more volatile than normal, but there will always be times like this if you invest for a long period of time.

Note also that you would have come nowhere close to 9% if you had timed the market wrong and been on the sidelines during critical periods.  For example, if you had gotten distraught after the collapse in 2008 and sold out, you would have missed out on a 36-40% increase in 2009.  If you had thought that the market moved up too quickly in 2009 and sold out, expecting a pullback in 2010, you would have missed out on a 25% return.  Either one of these moves would have reduced your annualized return drastically.

So the real answer to the question about what kind of return you can get from stocks and stock mutual funds is that you can get between 12% and 15% over long periods of time.  This will come with some spectacular years where you earn 40% or more, and some bad years where you’ll lose 40% or more.  You won’t know during any one-year, or even three-year or five-year period what kind of return you’ll get or even if you’ll get a  positive return.  This is why you should not invest money you’ll need in a short period of time unless you can afford to lose a portion of that money.  For example, if you have $100,000 but really only need $30,000 in three years, you might be willing to invest it and take the risk of losing $50,000 for the chance of making $50,000 over that period.  If you really needed the full $100,000, however, you would be much better off just putting the money in a bank CD where you would know it would be there in three years rather than hoping that things would work out.

If you don’t need the money for 10 or 20 years, however, you really should invest the money in equities since the returns you will get will be far better than you will see in bank CDs or even bonds.  You can also then start to use a financial calculator, plug in an annualized return of 12% or 15%, and get an idea of what you account will be worth in 10 or 20 years.  You just don’t know what the value of the account will be in any given year within that period.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Getting Better Returns from Your 401K and Mutual Fund Portfolio


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In Mutual Fund Investing Isn’t That Hard – Get Over It I discussed the big mistakes that investors make when handling a mutual fund portfolio or a 401K.  Most of these were things like not contributing enough, withdrawing your seed capital, or keeping too much in cash.  They really didn’t have much to do with the funds selected.  This is because most funds buy about the same stocks, so your results won’t be all that different if you do a good job of selecting funds or not.  It is really a matter of whether you’ll have $10M at retirement or have to get by with $8M.  The most important thing is to save and invest regularly and not use your 401K as a piggy bank to go on a trip or do a home kitchen upgrade.

There are ways, however, where you can improve your returns by a few percent, which will mean you’ll have a few million dollars more at retirement.  Doing these things really doesn’t take a lot more time, so if you are willing to learn and practice them, it is worth the effort.  So bookmark this post, send it to your friends, and refer to it often.  Here are the ways to get that few extra percent out of your mutual funds, which adds up to a lot of money over many years:

1) Buy the funds with the lowest fees.  If you have two different stock fund that have several billion dollars under management, they will hold basically the same stocks.  This is because they have so much money to invest that they need to buy many different stocks.  The managers buy their top pick, their next top pick, and probably their third and fourth pick in a sector.  So paying extra for a manager will probably not get you any higher return over long periods of time.  Their higher fees, however, will eat into your profits for sure.  Given the choice between two funds in the same sector of the market (large caps, international, etc…) buy the one with the lowest load and yearly fees.  Usually this is an index fund, which is unmanaged and therefore doesn’t need to pay for managers and research.

2) Spread your money out.  You will never know which sector of the market will perform the best.  Sometimes large cap stocks will do well.  Other times it is small caps.  Sometimes value investing works.  Other times it is growth and momentum investing.  The US is also not always the best place to invest – sometimes it is going well  overseas while the US is in the doldrums.  Buying into different sectors means you will never have all of your money in the hottest sector, meaning you’ll never have the maximum return possible.  Still, it does mean that you will have some money in the hottest sector at all times, which beats missing out on the best returns most of the time because you’re fully loaded into the wrong sector.  Given that you’ll never know which sector will do the best during any given period, diversification is better.

Good diversifications doesn’t just mean buying different funds since many funds will invest in the same stocks.  Instead, try to buy funds that invest in specific sectors, such as a large cap fund, a small cap fund, a mid cap fund, an international fund, an emerging market fund, and so on.  You can also add things like REIT funds to add real estate to your investment mix.  Buying a total market fund, which purchases stocks in every sector of the market, is also an option if you want to keep things simple and don’t want control over the percentages invested.  In managed funds, you should look for both a momentum (growth) fund and a value fund.

3)  Rebalance one a year.  You might diversify well but then after a few years your funds become unbalanced.  Maybe large cap stocks did much better than small caps so your large cap fund is oversized.  If there is a decline in large caps or a rally in small caps, you then won’t do as well as you would have had you been properly balanced.  For this reason, you should periodically rebalance your accounts, selling shares of those that did well and buying shares of those that did less well.  Most mutual fund companies have a way to do this with just a few clicks of the mouse.  This should done at most once or twice a year, preferably in the Spring since there is usually a rally in stocks in the winter months through the first month of the year.  You could just rebalance on your birthday or some other day you can remember.

4)  Overweight in the types of funds that perform well over time.  During the last several years, growth funds have outperformed value funds.  Over long periods of time, however, value funds come out a few percentage points ahead.  Small cap stocks have done really well over the last few years and look a little frothy at the current time, so it might not be the time to overweight in small cap stocks, but over long periods of time, small caps do better, so when they don’t look so expensive, you might want to have a slightly larger portion of smallcap stocks than largecaps.

5) Hold off on bonds until you are close to needing income from your portfolio.  The standard advise is to “buy your age” in bonds, meaning that a 30 year-old would have 30% of his portfolio in bonds.  The trouble is that bonds will return around 6-8% over long periods of time, while stocks will return 12-15%.  Why would you want to have 30% of your portfolio in something that returns about half as much for 35 or 40 years?  It is true that bonds calm down the gyrations in the value of your portfolio and that you need to start shifting into assets that will pay interest payments as you near the time when you’ll be drawing income from your portfolio since this will both provide the cash you’ll need to spend and reduce the chance that a big market downturn will devastate your portfolio, but with 15-20 years to go, it is probably better to stay in all stocks and REITs.  Building up cash to allow you to wait out a market downturn rather than buying bonds if bond yields are very low, as they are now, is also a strategy to consider.

6) Think about adding a few individual stocks.  You can’t do this with a 401k, but you can in an IRA or taxable account.  Here you’re trying to pick a company that does really well over a period of decades rather than finding a stock that will do well in any given year, so think like you’re buying into the business as a partner rather than simply trading a stock.  Worry more about fundamentals and less about the price movements of the stock.  Pick a few great growth companies, preferably the best ones in a few industries, and buy 500 to 1000 shares of each.  Make these stocks you plan to hold for decades.  If you do well with one of the companies and it becomes too large a portion of your portfolio (for example, you have $500,000 in assets and one of the companies makes up $100,000 of your total), sell a few shares and put it into additional indivdiual stocks or add to your mutual funds.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Mutual Fund Investing Isn’t that Hard. Get Over It.


In listening to advertisements from financial advisers, you would think that if you don’t select just the right funds for your 401K you will retire a pauper.  While there are certainly some big mistakes that you can make with a 401K or mutual fund investing in general, most of them really don’t have that much to do with fund selection.

Yes, it is true that there are ways to juice your returns a little bit, at least most of the time.  And it is true that if you increase your returns a little, you’ll end up with a lot more (in dollar terms) than you will if you don’t.  But still, if you have two middle-class individuals who both invest 10-15% of their paychecks regularly in a set of mutual funds, they’ll still end up multi-millionaires at retirement.  The person with the better strategy may end up with $8M while the one who doesn’t might end up with $6M.  Yes, $2M is a lot of money, but compare this with the person who doesn’t think about retirement until they are fifty or even sixty years old (in other words, 95% of people).  These folks will be lucky to scrape together $250,000 before retirement.

The thing you should worry about more is some sort of wealth tax or confiscation of assets in the future in the name of “fairness” because of wealth inequity such as this.  Nevermind that you saved 15% of your paycheck to allow you to end up with several millions while many other people spent their entire check (and then some), and that’s why they ended up with nothing for retirement.  It is easy to stir up a nation full of grasshoppers against a few ants.

The investing part though is relatively easy.  1) Select a large cap fund, a small cap fund, an international fund, and a high yield (bond) fund.  2) Put money into the bond fund equal to your age minus 10.  If you are less than 50, you might want to not put any in the bond fund at all if you can handle the ups and downs of the market (bonds help to smooth out the ride but reduce your long-term returns).  3) Divide the amount that remains about equally into the three stock funds.  You’re done!  Then, just rebalance the money about one a year to do a little better.  If this is too much, just use a total market stock fund and an international fund, divided about 70-80% domestic and 20-30% international with the rest in the bond fund.  Still too hard?  Just use a target date fund corresponding to your birthdate, or your birthdate plus 10 years if you want a little better return and don’t mind the volatility.

So what are the big mistakes to avoid when investing for retirement or building a portfolio of mutual funds to become financially independent?  Note that fund selection isn’t one of them, since investing regularly in most common stock funds is profoundly better than not investing at all.

1)  Spending principle.  The biggest mistake you can make is to withdraw the money from the mutual funds and spend it.  You will never be able to build up funds and take advantage of the power of compounding if you keep eating your seed corn.  Withdrawing and spending the money from a 401k (or even doing something like using your 401k like using your 401K funds to start pay off your house or start a business) is even worse since there you’ll pay out about half of the money in fees and taxes.  To be successful at investing you need to have the attitude that once money is invested it must stay invested.  Only the interest and gains can be spent, and most of that should be plowed back into the investments while the value of assets you have is small so that your portfolio can grow.

2) Holding too much cash.  The second biggest mistake is to hold too much in cash assets such as bank CDs and money market funds.  These assets will lose 2% or more each year to inflation, so if you hold onto cash assets for long periods of time your spending power will deplete.  Money that is not needed for five to ten years needs to put in assets that increase at least as rapidly as inflation, which means stocks, real estate, and bonds.

3) Making large moves to try to time the market.  It is often tempting to sell out and move into cash when the market has had a big run-up and everyone is saying that it is due for a correction.  The returns of 10-15% you see over long time periods in the markets, however, are due to just a few short periods of time when the market was on fire.  Take those away and your return will drop drastically.  If you are close to retirement you should be building up cash for the money you’ll need right away in any case.  If you are a long way from retirement, you need to just sit tight and accept that there will be some drops in value along the way.  If it makes you feel better, hold some of your contributions in cash and wait for a dip if you feel the markets are really frothy.  It is probably a better strategy, however, to wait for the dips and then increase your contributions for a period.  In any case, make sure you stay almost completely invested so you don’t miss the big moves.

4) Having a lot of your money in single positions.  It is a really bad idea to have more than about 10% of your funds in a single stock, bond, or other asset.  (Having them in a single mutual fund is different since the fund is invested in many companies.)  The most common time when this occurs is when a company gives out shares of its own stock as a matching portion of a 401k, as a bonus, or as another means of compensation.  You might work for a great company, but shed the shares as soon as you can.  You don’t want to lose your job and see your retirement account devastated the same day.

In the next post I’ll talk about the small mistakes that people make when investing in retirement accounts and mutual funds.  Avoiding these mistakes can increase your returns and help you end up with a few million dollars more at retirement, but they aren’t as important as avoiding the big mistakes.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What is a Blue Chip Stock?



Blue chip stocks are large companies that dominate the industry they are in. These are household names that are in virtually every mutual fund and portfolio. International Business Machines (IBM) has the nickname “Big Blue” since it used to be one of the biggest and most owned company in the world.

Most blue chip stocks have been around for many, many years. These are companies like Coca-Cola, Home Depot, General Electric, Exxon, and Microsoft that have been through many business cycles and used each downturn to take business away from rivals and come out a stronger, larger company. They tend to have thousands of employees and be in several different markets.

Probably the most famous list of blue chip companies is the Dow Jones Industrial Average, or DJIA, which contains the largest and most influential industrial companies. The idea behind the DJIA is that where the DJIA goes, so goes the economy since the most important companies in the economy are in the DJIA. There are also blue chip companies in the Dow Jones Transportation Index and the Dow Jones Utilities Index. Dow theory says that if the Transports and the Industrials are either rising (in an uptrend) or falling (in a downtrend), then it is a true trend. If they are mixed – one going up while the other goes down – then it is not a true trend.

The easiest way to spot a blue chip is just to look for the dominant companies that you know. Blue chip stocks are the companies like McDonald’s that a school child would choose in a stock picking game because they have been heavily advertised to by them and they know their products well. Most blue chip companies are also probably companies you’ve grown up with, although the internet has caused some blue chips to be developed very rapidly. For example, Amazon did not exist before 1994, yet by 2000 it was a household name and was dominating the selling of virtually everything. Google is another example that grew very big very fast.

Blue chip companies are sometimes good choices for growth – some large companies do very well over certain periods of time, but generally they are purchased more for stability than for growth. Many also pay good dividends, and grow their dividends regularly, so they are a good way to generate the income needed once you begin using your portfolio to pay for current expenses. The reason they are not as good for growth as small companies is that they are already so large that it is difficult for them to do things like double profits, which is what is needed to double their share price.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Things You Wouldn’t Need to Do with the Fair Tax


OLYMPUS DIGITAL CAMERAPromoters of the Fair Tax point to things like the ability to collect your entire paycheck instead of having a portion withdrawn for taxes before you see it.  They also talk about how under-the-counter businesses would pay their fair share, instead of getting money tax-free as they do now, since they would be buying things too.  Even drug dealers and prostitutes would be contributing to the tax base, lowering taxes for everyone.   Still interest has been limited, largely I believe because people don’t realize just how much of a timesaver it would be for everyone.

In a nutshell, the Fair Tax is a sales tax on new goods that would replace the income tax, Social Security Taxes, and all other Federal taxes.  You would still see state income taxes if you are foolish enough to live in a state that has them (I’m talking about you, California), but there would be no federal taxes.  There would also be no corporate income taxes, which means that groups like Burger King would not be fleeing the country for places with lower taxes like Canada.  Instead, businesses would be flocking here because they would not need to waste lots of money on tax planning and tax avoidance.

To prevent being regressive, meaning that poor people wouldn’t end up paying a greater percentage of their income than rich people, there would be a prebate where everyone would get a check from the government to cover a portion of the taxes.  For example, give a $10,000 per year prebate out to everyone with a 20% Fair Tax and no one who makes less than $50,000 per year would pay any taxes, even if they spent their entire paycheck on stuff that was subject to the Fair Tax.

A lot of the advantages of the Fair Tax go beyond getting your whole paycheck each month.  The Fair Tax greatly simplifies accounting and record keeping since you would not need to prove to the IRS what you made and what you spent on deductible items.  What would you not need to do if there were a Fair Tax instead of an Income Tax?  Let me list them:

1.  You would not need to give you Social Security number for a job, a bank account, or any other purpose, because there would be no Social Security numbers.  Credit card companies would actually need to do their jobs and verify your identity instead of relying on a number.

2.  You would not need to turn in a W-4 listing dependants, because there would be no withholding of taxes from your paycheck.

3.  You would not need to keep a receipt from the doctor’s office, because there would be no need to prove medical deductions.  You could throw them out.

4.  There would be no need to keep charitable donation receipts, because you would not need to claim them on your taxes.  Worried about losing the deduction?  Don’t be – you’ll be taking home more money, leaving you free to give or keep as you desire.  Your “charity” would not even need to be  officially recognized by the IRS.

5.  Conservative and Liberal groups would not need to submit any paperwork to the IRS for approval, because there would be no taxes on any contributions they received.

6.   You would not need to fill out paperwork for home energy improvements to get a tax deduction.  Politicians would just make such items exempt from the Fair Tax or reduce the Fair Tax on them if they wanted to keep using the tax system to drive behaviors.

7.  Seniors wouldn’t need to worry about paying income taxes on the Social Security benefits if they made too much money before retirement age and were taking benefits early, because there would be no income taxes.

8.  You would not need to fill out tax forms in April, because there would be no income tax and the IRS would never bother you unless you ran a business that collected the Fair Tax.  The IRS could be cut by 95% or more.  There go the Star Trek skits.

9.  You would not need to worry about contributing to medical savings accounts, retirement accounts, and college savings accounts before a certain date each year. You could start whatever accounts you wanted and fund them as you wish, because there would be no income taxes on the earnings.  You could also withdraw the money as needed because there would be no penalties to pay.

10.  You could give as much money as you wanted to your children or whomever else you wanted at any time because you would not need to pay estate or gift taxes.

So, what will you do with all of the time you’ll be saving by not needing to fill out tax forms, not needing to fill out  employment forms, and not needing to keep and organize receipts?

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Cashing In on Retirement


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In this month’s Money magazine there is an article by Penelope Wang about how much cash you should have as you enter retirement called “How Much Cash is Too Much.”  In the article Ms. Wang talks about the need to balance safety and growth.  Take too much of a risk and a sudden market plunge could wipe out half of your portfolio, which could be a disaster if you were just starting retirement.  Put too much in cash, however, and you won’t see the growth you need to sustain you through a long retirement.  Remember that inflation is constantly eating away at your buying power even if your account balance remains unchanged.

Marc Freedman, a financial planner cited in the article, recommends keeping no more than a couple of years worth of spending needs in cash, split between bank assets and short-term bonds.  This assumes that you have a pension or other source of income like an annuity to pay for basic expenses.  (Note that I would not even include Social Security in your calculations with the government more than $17.8T in debt.  Some thing needs to happen at some point and you won’t want to be relying on a check from Uncle Sam when it does.)  The idea here is that if there is a market correction like in 2008, you would have enough cash to hold on until the market recovered without needing to see stocks at fire sale prices.  Personally I would keep maybe four or five year’s worth of expenses in cash because while the markets normally recover within a year or two after a fall, sometimes stocks languish for a longer period of time, particularly if the government tries to “help” the economy through regulation or economic actions.

He also recommends budgeting for “unplanned expenses.”  The article cites an example of an adult child moving back into the home.  While I understand that things happen in life, it seems that by the time one is ready to retire, children should be at least into their thirties.  It seems like they should be able to contribute to the household income, at least enough to cover the extra money you’ll be spending for food and utilities because they are there.  Just because they move back in doesn’t mean they are suddenly 12 years old again and you should pay for everything, but I digress.  Other unplanned expenses could be things like a medical procedure that requires money for the deductible, a car breakdown requiring the sudden replacement of a vehicle, or home damage from a  fallen tree.  Certainly keeping some extra money on hand should something like this happen right after a market meltdown would be wise.

In keeping “cash,” you should still do all you can to help preserve it from inflation.  One idea would be to stage it so that money you do not need soon is allowed to make additional interest through the use of longer-term cash assets.  For example, you might place the money you need within the next year in a money market fund.  Money needed for year two could be placed in a one year CD.  Money needed for year three could be placed in a 2 year CD.  Money needed for years 3-5 could be placed in longer-term CDs or perhaps bonds that expire at appropriate intervals.  In this way you are preserving a high level of safety but getting a better return than you would in a money market fund (or placed in a shoebox under your mattress) by agreeing to lock the money in for a period of time.

Another consideration is the security of the accounts.  While government insurance protection has gotten more generous since 2008, you might still consider spreading the money out into a couple of different banks.  If there were some sort of credit crunch at one bank, it might take a while to get your accounts restored.  Having two or more banks reduces this risk.  This would also provide some level of protection from account take-over fraud and other types of identity theft since your money would not all be in one place.

Another thing to consider is the amount of assets you have when you enter retirement.  An individual with less than $500,000 in assets is taking a big risk of running out before the end of a long retirement.  Such an individual also wouldn’t be able to invest a significant portion of their money in  stocks or other volatile assets because they could not withstand a large drop in value.  For such an individual, something like an annuity may make sense since at least it guarantees a level of income.  There would also be the issue of medical bills, which can easily reach $250,000 in retirement, but relying on the generosity of the public and using Medicaid might be the only option here.

An individual with $1 M in assets is on the border line where a portion can be invested to gain a better return.  An annuity could still be purchased with a portion of the portfolio if desired for guaranteed income, although a price would be paid for that income since insurance companies don’t issue products that they don’t, on average, make money.  Such an individual would also want to have an ample cash reserve of four to five year’s worth of expenses to guard against market declines since a 50% drop would place them int eh same place as the person with only $500,000.

An individual with $2 M or $3 M starts getting to the point where a good portion could be invested.  He could treat the first $1 M as did the individual with only $1 M total and then take the additional millions and invest fully.  On years when the market does well, he could add to his cash pile and increase spending.  On bad years he could sit pat and wait for a better year.  At some level of net worth, maybe $5 M or more, a smaller cash reserve than seevral years could be held since even if there were a significant market decline the individual would still have ample assets to cover living expenses.  This is why it is important to save and invest for retirement early so that you will have more than enough.  This leads to a much more comfortable retirement than can be had living right on the edge since you can take more risks and get higher returns.

A final consideration when going into retirement is cutting recurring expenses to the minimum.  Certainly you should pay off your home so the only thing you need to pay each year to stay in your home is property taxes.  You also might consider scaling down in home to cut the costs of maintenance and taxes.  Any credit cards should be paid off and consumer loans retired.  If all you really need to buy is food, clothes, utilities, and medicine it will allow you to cut spending drastically should the need arise.

Proper cash management when going into retirement is critical, particularly during the first few years when a market downturn could seriously jeopardize your chances of making your money last.  It is much more difficult than when you are young and building wealth.  Probably the best thing to do is to build up a more than ample portfolio of assets to make it through.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Learning Investing from My Father


Many families never talk about money (or sex), seeing the subjects as taboo for discussion between the generations.  Schools have taken on the responsibility of teaching sex (although without teaching any of the morals, because that would be judgemental, teaching religion, or old-fashioned), but there is still very little taught in the area of personal finance.  Some students – generally the ones who the schools decide won’t be able to understand algebra,  and are therefore relegated to “consumer math” – may get some of the very basics on the mechanics of handling money.  They get very little good advice on budgeting and investing, however.  In fact, they are often taught how to do things like use credit cards and take out consumer loans – the things that many should really avoid.

Our family was somewhat odd in that we were investors, or at least my father was.  I remember from the age of nine or ten seeing him at his desk in the corner of our livingroom, a desk lamp shining on the sheets of graph paper where he would dutifully write down the closing prices for his stocks each day.  There were no websites to give you stock quotes.  He would use the stock tables in the C section of The Wall Street Journal which had listings for the NYSE, the NASDAQ, the American Exchange, and bonds and other investments.  He would write down the prices on one sheet and then graph them on the next, making a series of dots for the closing prices with a line connecting them.  He would use a four-color ball point pen to plot four stocks on each sheet of paper, each in its own color.  Each sheet of graph paper would last for about three months before he would need to start a new sheet.

I got interested in what he was doing and started asking questions.  Eventually, at the age of 12, I decided that I wanted to invest the money in my savings account – a grand total of $225 – in stocks and asked him to help me.  At that time a savings account would routinely pay 5%, which I thought was the standard rate that such accounts would always pay.  I didn’t know that inflation had gotten way out of control under the Carter Administration and that the Federal Reserve has raised interbank interest rates to 18% or more to try to kill the beast that was devouring savings.

My father pulled out his thick binder that held his Value Line Investment Survey as I had seen him do many times before.  We went to the back of the index section that had the stocks ranked 1 and 2 for Timeliness, a proprietary measure Value Line uses to rate how they believe  stocks will do over the next year.  Those with a “1” are expected to do the best, followed by those with a “2”and so on, down to the 5’s that are expected to lag the pack.  He set the criteria to find stocks that had a 1 or 2 for Timeliness and at least a 3 for Safety, another Value Line measure.  We searched through and settled on Tucson Electric Power, a utility that provided power for Tucson, Arizona.

The next day he called his broker and placed the order for 15 shares of TEP at $15 per share.  I remember how excited I was when the order executed and I was a stockholder.  We got a certificate sent to our home and I admired the elaborate art work with a goddess holding bolts of lightning in her hands.  It indicated that I was the proud owner of fifteen shares of stock.  I folded the certificate and kept it in my top dresser drawer for years until my father decided to take it to the safe deposit box.

My stock did very well, growing from $15 per share to over $75 per share over the next few years.  I signed up for the dividend reinvestment program and sent in additional money from time to time to buy more shares directly through the plan, brokerage-fee free.  I lost track of the prices I paid and my cost basis, making it so that I could never sell the shares since then I wouldn’t know what my capital gain would be for taxes.   I didn’t really care because I would get a dividend check every three months anyway so long as I held onto the shares.

Eventually the company got involved in a scandal.  Allegedly the executives were using the revenues from the utility operations to fund highly speculative ventures that looked good on paper but whose true performance was being masked.  The price of the stock tumbled quickly after the news came out, falling back to about $20 per share.  When I went to college, coincidentally in Tucson, there was a special shareholder meeting to enact a measure that would dilute the shares by issuing a great deal of additional shares in order to pay off creditors.  I attended the meeting and heard the complaints from longterm shareholders who held far more shares than me.  I held on anyway, partly because I didn’t know my cost basis, and saw the shares drop to less than $2 per share.  The dividend was eliminated for several years, but it was eventually restored and grew over the years to a respectable sum.

Along the way through my middle school and high school days I acquired shares in additional companies.  Starting from eighth grade I needed to file tax forms.  I never actually owed anything, but apparently I was above the threshold where I needed to file anyway just to prove to the IRS that I didn’t owe anything.  My family paid an accountant to prepare the forms, so we ended up paying out a couple of hundred dollars each year to file forms that did nothing other than prove we didn’t need to pay taxes.  That is one reason I’m a strong advocate of the Fair Tax.

As I got older my father and mother started putting money for my college and my early adult life into a brokerage account for me.  My father owned a large number of shares of Citizen Utilities that he transferred to me a little each year under the gift tax exemption.  I then sold these shares off and bought other stocks with the money, developing a portfolio of several stocks.  This ended up being a bad idea since I then got his cost basis for the shares, which was very low, and therefore owed quite a bit in capital gains taxes when I sold the shares.  Actually this might not have been a bad strategy overall since my tax rate was lower than his (I think capital gains were taxed like ordinary income at the time), but it resulted in a net transfer of less money to me.  In any case, I was able to pay for college expenses using the portfolio rather than calling home for money each time I needed it.

I also remember in grade school and high school sitting with my father each evening at 5:00 when the Nightly Business Report would come on PBS.  We would watch the show for the first 15 minutes as they went over the movements of the Dow and other indices for the day, the closing prices of several large  and widely held stocks,  and the biggest gainers and losers.  Once in a while I would see a stock that I owned rise or fall dramatically.  If it did not show up on that segment of the show I would need to wait for the next day to read about the closing prices in The Wall Street Journal from the stock tables.

On Saturdays my father would get his issue of Barrons magazine, the weekly sister publication of The Journal.  I enjoyed reading the column by Alan Ableson.  He always had a very witty column that lead the magazine, called “Up and Down Wall Street,” that reviewed the happenings for the week.  I usually had a dictionary nearby because he would use large words not found in normal newspapers that are dumbed down to a fifth grade level.  I found when studying for the SAT that my dad knew every vocabulary word on the list, probably from forty years of reading Barrons.   The column was always very depressing; Ableson was the eternal pessimist who could find the dark cloud in any silver lining.  I can remember very few times when he didn’t think the market was going to hell in a handbasket.  Still, he wrote in such a humorous way you would laugh through the tears.

Sadly my father developed dementia in his later years and became unable to maintain his portfolio.  He also became very concerned that he had lost all of his money, apparently a symptom of the disease since I checked on the value of his accounts (for the first time in my life) and saw that he was in fact doing fine.  My mother was also unable to manage things, being used to having her husband just take care of the finances, so I obtained power of attorney over the accounts and began to manage them for my parents.  At one point I got my own subscription to Value Line but would still periodically flip thorough his old binder when I was home for a visit.

My father eventually suffered a fall, went into a nursing home, and then passed away a couple of years later.  My mother subsequently passed about seven years after him.  This left me in the oldest generation of our family when I was just in my late thirties.  I was certainly able to take care of myself and my own finances by that point, but I miss the connections to our family history that went with them as they left this earth.  There are many questions I never asked and now have no way to do so.

About a year ago I was flipping through the channels on a Monday afternoon and saw that the Nightly Business Report was coming on.  The white-haired host that I remember was gone, replaced by a tag team of anchors.  Still, they followed the familiar format of the show for the most part and I remembered sitting there in our old family room with my father.

Then last year, after not reading Barrons for a while, I picked up a copy and wondered if Alan Ableson was still writing his witty “Up and Down Wall Street” column.  I was greeted by a series of remembrances from other columnists from Barrons and elsewhere and an article on  the passing of Alan Ableson, who apparently had died during the previous week.  I was amazed that he had written that column for so many years, right up to his death and several years after the passing of my father.

With Ableson’s passing, one of the last connections I had with my father was lost.  Barrons still has an “Up and Down Wall Street” column, but it lacks Ableson’s humor and eternal pessimism.  I still think of my father though each time I pull out my thick binder with The Value Live Investment Survey to find new stock picks.  They now have an online version, but I find I like to leaf through the pages in the print edition and look at the price trends.  I also like to go to the tables with the high Timeliness stocks in the back even though I rarely find a stock that way anymore.

Just this last week, I received a notice that the holding company which Tucson Electric Power had become, Unisource Energy, had been bought out in an all cash deal and that I need to send in my certificates to get paid for the shares.  I guess my plan to keep the shares until I died and enjoy the quarterly dividends all the while so that I would never need to find the cost basis has been foiled.  I will probably need to simply set it at zero for many of the shares and pay the extra, unowed taxes since I can’t prove a higher cost basis for many of the shares and it would cost more to track down the basis that I would save.

There is provision in the paperwork that the transfer company sent with the notice of the sale where you can say the certificate is lost, sign a statement to that effect, and forgo$1.80 per share to insure against a certificate being sent in later by another party.  Perhaps I’ll do that so that I can keep the certificate I have for 15 shares, purchased at $15 per share.  That piece of paper with the goddess holding the lightning bolts is worth a lot more to me than the $27 dollars or so I would give up by holding onto it.  It brings back the warm summer afternoon where I searched through Value Line with my father when he was still in his investing prime.

Follow on Twitter to get news about new articles. @SmallIvy_SI. Email me at VTSIOriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.