If you liked the 1 percent difference from this week’s STOCK-tober column, try the 2 percent solution, too
(Oct. 15, 2012) – In this week’s Funny Money column, I talked about how being a One Percenter can help – or hurt – your portfolio. Investment management expenses, low saving rates and even rebalancing can add or subtract 1 percent a year from your returns, and make a big difference over time.
But what if you haven’t started a regular program of saving and investing for your future – retirement, buying a house, sending kids to college, financing your musical-comedy “Newt!” – you need to get going. It sounds tough, but it’s actually easy and not even that expensive, if you use the 2% Solution.
Let’s say you make $30,000 a year and live in my home state of Michigan. As a single person with nothing beyond the standard deduction, you’ll receive gross pay of $576.92 and take home $447.83, according to the take-home pay calculator at PayCheckCity.com.
Now, let’s take off 2 percent – a whopping $11.54 a week. At the end of the year, even if you get no interest, even if you stuff the cash into your mattress or a Mason jar in the yard or a bag of Birdseye Frozen Peas in your freezer (um, perhaps I’m getting a bit too specific here) you would have $600. OK, not enough to go shopping for a new BMW, but a tidy amount, accumulated with no more sacrifice than skipping a couple of lattes or two cheapo six-packs a week.
Every year, add another 2 percent. Ideally, you’re getting a raise at some point (believe me, it used to happen before the Great Recession). Again, you’ll hardly feel it, but in your second year, you’re saving $1,200 a year. Add that to the first year, and you’ve got $1,800 plus any interest. Because, really, the best way to do this is to have the money automatically sucked out of your bank account into a separate money market savings account. Look around online, and you can get the breathtaking return of 0.75 percent of even 0.90 percent.
OK, up it again, now in the third year, you’re saving 6 percent. You’ll save $1,800 this year, on top of the $1,800, plus interest from the previous two years. Now you’ve got $3,600 plus interest – the makings of a good emergency account. Set this aside and you’ll be amazed at what a terrific financial shock absorber this can be as you go through life. You won’t have to put an emergency on credit cards (assuming you’ve got one to use), you won’t have to borrow money from parents or friends to move to take a new job, you won’t have to duck collection calls from the hospital about that arm you broke while Jell-O wrestling at your friend’s bachelor party.
The trick here is to focus on just the amount of NEW savings you are adding each year. In a few years, the total will increase, and you’ll be tempted to say, “Wow – I’m taking $60 a week out of my paycheck, $240 or more a month!” and you’ll start thinking about the great, fun things you could buy with that money. Don’t do it. Just focus on the extra $11.54 a week or, if you did land that mythical beast called a raise or, better, a promotion, focus on how you paycheck is still higher than when you started saving a few years ago.
If you’re already saving, use the 2 percent rule to kick your contributions up a notch. The best way to make up for previous losses in invest, or low returns today, is to save more. Unlike what the rappers say, mo’ money nearly always means less problems.
If you’re putting that money aside in a tax-deferred account, such as a regular Individual Retirement Account or a workplace 401(k) savings plan, you’re doing even better. Because the 2 percent you’re setting aside doesn’t get hit with income tax. So you take home $439.16, according to our handy-dandy calculator. But wait – you’re also saving $11.54 a week, and that adds up to $450.70 – that’s $2.87 more than I had when I wasn’t saving any money at all.
Right you are, Rollo. You’re $11.54 in savings only cost you $8.67, because you’re getting a federal tax break. Your Uncle Sam will let you keep some more out of your paycheck and let your savings pile up and compound tax free – making you even more money – until you start taking withdrawals in retirement. And if you’re boss is adding an employer match, as most 401(k) plans do, you’re getting even more money and it’s costing you much, much less than the amount you’re actually sacrificing from your weekly take-home pay.
(One caveat: Not everyone is eligible to deduct contributions to a regular IRA plan. For instance, if you’re a single person making more than $68,000 a year and you are covered by a workplace pension plan, you can’t deduct. Check with our friends at www. IRS.gov to make sure you’ll get the tax break before you count on it.)
So, if you haven’t been saving, get started with just 2 percent. It’s painless and the money builds up over time, and your boss and the feds may even pay you to save. If you’re not saving enough, kick in another 2 percent.
You won’t be sorry later that you saved a little bit more now. But that’s just my 2 percent.
STOCK-tober extra: A few sample portfolios
(Oct. 8, 2012) – In this week’s column I look at how a diversified, conservative-oriented portfolio of just four indexes – T-bills, U.S. investment-grade bonds, the S&P 500 and international stocks – would have allowed an investor to survive the bust of the tech bubble, the drop after the September 11 terror attacks and the Great Recession and still show a real profit.
The sample portfolio used a lump sum that was re-balanced each January, running from January 2000 to December 2011, with no new investment (it also didn’t include dividends). This portfolio not only beat the dismal gain of just 1.53 percent a year returned by the broad U.S. stock market (as measured by the S&P 500) but, with a return of 4.05 percent compounded annually, also provided an inflation-adjusted profit of more than $3,000 on an initial investment of $10,000.
But as I say, that portfolio was pretty conservative: 30 percent in short-term Treasuries (essentially, cash) and 50 percent in investment-grade U.S. bonds, with just 20 percent in stocks, including 5 percent in international equities and 15 percent in large-cap U.S. shares.
That’s a great strategy for someone in or near retirement, or who doesn’t need a lot of growth (or can’t stomach the volatility of holding more stocks). If you were in the accumulation phase of your investing life, you probably wanted to put more into stocks, even if it lowered your return for those 12 years. If you were consistently investing new money – as with a 401(k) or similar workplace savings account, or an Individual Retirement Account – you’d be buying more shares on the way down, as the stock market melted down during each of those three crises.
This approach is called “dollar-cost averaging.” It means that $100 dollars invested when stocks are expensive buys fewer shares, and another $100 invested when stocks have tumbled to lower prices will get you more shares. The effect is to force you to buy more when stocks are low, less when stocks are high, and lowers your average price per share. Later, when share prices rise and you cash out, your gains are bigger because your initial investment was lower.
What it means is that, when you’re young, a crisis isn’t a terrible thing if you can afford to keep buying into the market, because you are accumulating a pile of bargains you can later cash in at a profit. You just have to, you know, deal with hanging on to your job, your house and the entire zombie economy of a recession.
A good model for a lifetime investing is the sample portfolio posted by Rick Meigs at his web site, 401khelpcenter.com. You can find it here:
I’ve been using an asset allocation model based on this for years. While I’m not one to obsessively check my returns, in the years when I have gone to the trouble, I’ve beaten the Dow Jones Index by as much as 24 percent, but that may have just been luck and the individual characteristics of the limited number of mutual funds available to me in my 401(k), which is only about 14 funds.
If you’re looking for a good model portfolio to start with, I think these are good basic approaches. You should, of course, do your own research and consult your investment and financial professionals if you want recommendations you can rely on. In the meantime, Rick’s asset allocation gives you plenty to think about as you create your own approach to asset allocation.
Younger than 40 – 100% in equities
- Large-cap growth funds: 40%
- Small-cap growth funds: 25%
- Large-cap value funds: 25%
- International funds: 10%
Age: 40 to 50 – 80% in equities and 20% in fixed income
- Large-cap growth funds: 32%
- Small-cap growth funds: 20%
- Large-cap value funds: 20%
- International funds: 8%
Age: 51 to 55 – 70% in equities and 30% in fixed income
- Large-cap growth funds: 28%
- Small-cap growth funds: 18%
- Large-cap value funds: 18%
- International funds: 7%
Age: 56 to 60 – 50% in equities and 50% in fixed income
- Large-cap growth funds: 20%
- Small-cap growth funds: 5%
- Large-cap value funds: 20%
- International funds: 5%
From age 61 to 65: Reduce equities by 5% per year and increase fixed income by 5% per year. The goal by retirement is to slow down to 25% in equities and 75% in fixed income. Of the equity portion, 40% invested in large cap. growth funds, 10% small cap. growth funds, 40% in large cap. value funds, and 10% international. Here’s the math:
Age 61: 45% in equities and 55% in fixed income
- Large-cap growth funds: 18%
- Small-cap growth funds: 5%
- Large-cap value funds: 18%
- International funds: 5%
Age 62: 40% in equities and 60% in fixed income
- Large-cap growth funds: 16%
- Small-cap growth funds: 4%
- Large-cap value funds: 16%
- International funds: 4%
Age 63: 35% in equities and 65% in fixed income
- Large-cap growth funds: 14%
- Small-cap growth funds: 4%
- Large-cap value funds: 14%
- International funds: 4%
Age 64: 30% in equities and 70% in fixed income
- Large-cap growth funds: 12%
- Small-cap growth funds: 3%
- Large-cap value funds: 12%
- International funds: 3%
Age 65: 25% in equities and 75% in fixed income
- Large-cap growth funds: 10%
- Small-cap growth funds: 3%
- Large-cap value funds: 10%
- International funds: 3%
If your investment firm, such as your company’s 401(k) provider), wants you to keep allocations to even 5 percent slices, just round up or down to the nearest 5 percent.
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That’s me in my costume from America’s Thanksgiving Parade in Detroit. The Detroit News sponsors the Uncle Sam balloon, and I help keep him from blowing away and emigrating to Canada. (I think he wants the free healthcare!)
(July 16, 2012) – Thanks for visiting the official blog for my syndicated column, Funny Money. This site is still a work in progress, but more content is on the way, including exclusive extra stories and advice on all the most common personal finance topics, from budgeting to debt to investing. You can find links to my current column and past ones, too. And I’ll be adding blog posts relating to current personal finance topics, as well.
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