How To Retire With Twice the Money, While Saving Half As Much.
What would you do if you could retire with more money than you thought possible, while saving less?
Below are four things that you must absolutely know about retirement planning if you want to retire earlier, with more money, while saving less. It’s one small part of what we share in our Retirement Investing Journal. One of our readers put it best –
“If I read this twenty years ago I’d already be retired”.
This Simple Short-Cut Doubles Your Retirement Money
Stay with me for a moment because this is the first key to doubling, even tripling your retirement savings – without having to save more money or take unnecessary financial risks that could put your retirement in jeopardy.
According to multiple surveys, individual investors don’t have a clue as to what they’re being charged in financial fees, not to mention the devastating impact fees have on their retirement accounts.
In the March/April 2013 issue of the Financial Analysts Journal for actively managed funds, the “All-In” Investment Expenses calculated by William F. Sharpe was 2.27%. (The typical fee a top financial advisor charges is 1-2% of your retirement assets, plus fund expenses).
To keep this simple, I’ll use 2% as the all-in costs of using a financial advisor and/or actively managed funds.
If you had $100,000 in your retirement account, at the 2% level, you would be paying $2,000 a year in financial fees. That’s lost money, but a fair price to pay for professional investment advice.
This is where it gets interesting.
Most people mistakenly believe that paying $2,000 a year in retirement fees over a 20 year period would cost them $40,000 (if their account balance stayed the same).
It’s actually a lot worse than that.
What if I told you the real cost isn’t $40,000, it’s $153,021.13!!
Let’s look at how to quickly calculate the real costs of financial fees to you over a 20 year time period. Why 20 years? That’s the average lifespan after the current retirement age.
The average annual return of an investment portfolio containing 50% stocks and 50% bonds has been 8.3% since 1926.
If you had $100,000 in your retirement account when you retired, didn’t add or withdraw money and earned the historical rate of 8.3% a year, you would have $492,384.76 after 20 years. That’s the power of compounded interest (and demonstrates why it’s so important to start saving early).
Let’s subtract 2% a year for financial fees and see what happens. If you started with $100,000, didn’t add any more money and earned 6.3% annually (the average historical rate of 8.3% minus 2% a year in financial fees), you would have $339,363.63 after 20 years.
That’s a difference (loss to you) of $153,021.13.
Now you know how the investment banks make so much money and why it’s so dang hard for you to retire with enough money to live a worry free retirement.
It’s one reason why Warren Buffett (link to essential warren buffett) and Jack Bogle continually warn investors about the destructive capacity of financial fees. Here’s what Warren Buffett has to say on fees and investing;
“The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time…”
“Both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm”
Granted, the above doesn’t take everything into consideration – I’m keeping it simple. But you get the point of this little exercise.
Essentially, the results across various scenarios show you’ll lose more money due to the current average cost of financial fees over 20 years than you’ve put into your account (due to the power of compounded interest). Read that again, it’s that important. In the above example, you had funded your account with $100,000 – but paid $150,000 in financial fees over twenty years’ time.
- The more money you have saved for retirement,
- The higher your annual returns and
- The longer you have your money invested,
-the more money you lose to financial fees.
How do you get around this problem?
If you’re going through your employer one of the easiest ways to reduce costs while maintaining performance is to use Target Date Funds. Target date funds provide you with a professional money manager and diversified investments for a lower overall cost. The best option is a Target Date Fund that’s built using Index Funds (lower fees). Be careful though, not all Target Retirement Funds are the same.
Robo-Advisors are a second option that is gaining in popularity. While it’s a step in the right direction you have to be very careful as you don’t have control over your investments and it can be hard to verify their financial stability. The investment process itself is automated and automated trading has been blamed for stock market flash crashes. The risks can be substantially higher if the firm exposes you to illiquid ETF’s. In addition, if they don’t offer model portfolios that can be tracked, it can be hard to verify their results and track record.
The third option is to manage your account yourself and use the best available Index Funds. That’s what we use in our market beating model portfolios in the Value Investors Associations Retirement Investing Journal.
The Insane Benefits of Saving Early
We’ve seen the devastating effects financial fees can have due to compound interest. Now let’s look at how compound interest works in your favor and why it’s so important to save for retirement as early as you can.
The assumption that I’ll use for this example is the historical return rate of 8.3%, which was used previously.
Saver number one doesn’t start saving for retirement until age 35 and then saves $400 a month towards retirement until age 67. Total invested towards their retirement is $153,600. After 32 years they have amassed $512,972.59 at retirement.
Saver number two saves $300 a month starting at age 25. After 42 years they have invested almost the same amount, $151,200. The big difference, is that due to an annual compound interest rate of 8.3% they have amassed $1,191,520.28 at retirement. Investing slightly less money, but starting earlier – doubled their retirement savings!
The news isn’t all horrific though if you haven’t saved up as much as you should have by now. As you grow older, your earnings tend to be significantly higher and hopefully, your discretionary income will be as well. You may be able to put aside $800 a month towards retirement at age 40 and still live a more comfortable lifestyle than putting away $200 or $300 a month when you’re younger and money is tight.
Quick Tip – Always try to at least put enough in your retirement savings to get the full benefit of your employer’s match (They’ll match 50% of your monthly contribution up to 6% for example)
The most important thing to remember is this. Save as much money as you can, as early as you can, without depriving yourself of a satisfying life (after all – we don’t all make it to the end).
When’s the best time to start investing? Now!
Skip This and It Can Lead to Devastating Consequences
Did you know that a portfolio of 70% U.S. stocks and 30% international stocks or 50% U.S. Stocks, 25% developed country international stocks and 25% emerging market stocks has earned about 2% more a year compared to just holding U.S. stocks with LESS risk over the past 40-50 years.
As you’ve already seen, an extra 2% a year can double your returns after 20 years.
Diversification helps you manage risk to make sure you don’t suffer devastating losses (think financial crises of 2000 and 2008) and have enough money saved for retirement. This is particularly important for those nearing retirement age.
If you think you can outsmart the market and don’t have to diversify, consider this. CXO Advisory Group measures a group of market “gurus.” These include professional money managers, newsletter writers, and financial columnists. Everyone on the list is a professional. The average accuracy of the group in predicting future price moves is less than 50%. That’s worse than a coin flip! These are the best in the business, and they can’t even predict the future over half the time.
John Templeton was one of the most successful investors and mutual fund managers of all-time. Here’s what he has to say on the subject of diversification; “In my 45-year career as an investment counselor, humility did show me the need for worldwide diversification to reduce risk.”
Passive index investors have all but forgotten about diversification because they’ve been told that they really don’t have to worry about it anymore. Just put your money in U.S. stocks and you’ll be OK. What a huge mistake that can be as it has led to long periods of poor returns in the past.
REMEMBER THIS: Manage risk first, growth second.
The Biggest Mistake That Ruins Individual Investors Retirement Accounts – And How to Fix It
We’ve already covered the futility of trying to predict the future, but you can use probabilities and valuations to increase your returns substantially while reducing your risk of large losses. What that means is more money in your retirement account with less risk.
If you’re young and still believe you can sock away 80-90% of your money in stocks without harm, you’ve never lived through the lows of the stock market from 1896-1932 or 1962 to 1974. That’s not even mentioning the two devastating stock market crashes from 2000-2002 and 2008-2009 during which time the stock market lost over half its value.
The Great Lie Told to Passive Fund Investors
The stock market doesn’t return 9% every year or even every 10 years as you’ve been led to believe.
When the market is undervalued such as it was in 2003-2204 and 2009-2010, it returns for more over the next few years. When it’s overvalued such as it was in 1927-1928, 1999-2000, 2007-2008 (and we believe 2015-2106) the risk is much higher and the returns are much smaller over the next few years.
Don’t buy into the lie that all you to do is keep your money in stocks no matter the valuation and you’ll be safe. The market doesn’t work that way.
The Big Lesson
When the stock market has been steadily rising in price investors get a false sense of security and believe everything is safe. During this time they start to allocate more of their investment funds to stocks and other risky investments telling themselves that this time is different, they’re money is safe because……
“The four most dangerous words in investing are: this time it’s different.’” – John Templeton
For example, investors piled into stocks in 1998-1999 and 2006-2007 when they felt safest and ran stock valuations to all-time highs, only to suffer severe losses of over 50% in 2000-2001 and 2008-2009.
Investors then compounded the mistake by holding the lowest percentage in stocks in 2003 and 2009. This is when the market looked its bleakest but was undervalued because investors were scared. The result: they missed the incredible stock market returns in the ensuing years putting them further behind in their investment goals.
If you want to retire with more money with less risk, you have to do the opposite to be successful. When market valuations are at historically high levels, become more conservative in your stock holdings. When market valuations are near historically low levels, you can become more aggressive.
“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett
But that’s not what’s happening. Investors are repeating the same mistake in 2015-2016 that they did in 1999 and 2007, pushing stock valuations to historically high levels. It’s but one reason why we alerted readers of the Value Investors Association Retirement Investing Journal to become more conservative in their stock allocations in late 2015. Or at the very least, to remember to rebalance their portfolios to protect the impressive stock gains over the last 6 years. (In our retirement investing journal, we provide you with model portfolios and the relative information you need regarding current valuations and probabilities).
Quick Tip: Don’t try to predict the future but use probabilities and valuations to guide your long-time investment decisions and put the numbers in your favor.
At the very least I hope this brief overview provides you with enough information to have an intelligent conversation with your employer or financial advisor about your retirement planning. In addition you’ll also want to learn three other hidden secrets that investment bankers and financial planners hope you never find out about
In closing, consider joining our family and becoming a member of the Value Investors Association to help protect your financial future and that of your loved ones.
Sincerely Bob Howe