Thursday, March 3, 2011

Five Rules for 401(k) Savers

 
 

Sent to you by donellfactory via Google Reader:

 
 

via Forbes Network Activity by William Baldwin on 3/3/11

Beach chairs by the sea

Image by Adventurous Wench via Flickr

Are you bewildered by all the choices in your retirement plan? Frightened that you won't have enough to retire on?

Follow these simple rules.

Rule #1. Don't have car payments.

Car financing? What does that have to do with your retirement? A lot.

The main problem people have with 401(k)s is that they don't put enough in. And one reason they don't have the money to put in is that they are paying interest on car loans and credit cards.

Your next car should be whatever you can afford to buy for cash. It will probably be used, maybe with a few small dents.

Take the $1,200 a month you would otherwise have shelled out on a Lexus LX lease and divide it in two. Put $600 a month into a car buying kitty. Use this to buy a better car some day—for cash.

Put the other $600 into your 401(k).

Never carry a credit card balance. Your credit card should be paying you 2%.

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Rule #2. Calculate your expense ratio.

Example: You have $100,000 in Mutual Shares, an actively managed stock fund that costs 1.83% a year. You have $60,000 in Loomis Sayles Strategic Income, an actively managed bond fund that costs 1.71%. The combined cost is 1.83 x 100 plus 1.71 x 60, divided by 160. It's just shy of 1.8% a year.

If you had the same amounts, respectively, in the Total Stock Market and Total Bond Market index funds from Vanguard, your expenses would be just under 0.2% a year.

The difference between these particular actively managed funds and the inactive alternatives is 1.6% a year. What does that mean after 30 years of saving? It depends on future raises and such, but it's easily going to cost you a third of your retirement pot to own the fancy funds.

You say: Yes, but my funds are going to beat the market.

Well, maybe they will. Guess what? Every single actively managed fund is supposed to beat the market. Outside of Lake Wobegon, it's impossible for everyone to be above average. What makes you confident that you will do better than average while the next fellow will do worse?

If you want to switch into cheap index funds but can't because your company doesn't offer them, raise hell.

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Rule #3. Own few funds.

Like, two of them.

I see portfolios with a dozen. A small-company growth, a large-company value, a rising dividend this, a strategic opportunity that.

What's the point? It's not like you're furnishing a living room and need a side table and a sofabed and a Barcalounger.

Combine a large collection of funds over a long period and you have all but guaranteed yourself a return the same as what you would have had on an index fund. Except that with the collection you are paying a whole lot more in fees.

Beginners should have one stock fund and one bond fund. After your balance passes $100,000 you can add an international stock fund and a junk bond fund.

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Rule #4. Don't own stock in your employer.

Coca-Cola employees have half their retirement accounts invested in Coke stock. Now, Coke is a great stock, and probably a great place to work too, but it's a bad idea to combine work and investing. What if the world switches to tap water? Employee-shareholders get a 401(k) crash and a pink slip the same day. Exactly that happened at Enron.

If you get a 15% discount on company shares, or you are obliged to take a certain amount of your 401(k) match in stock, take the stock. Then sell it as fast as you can without penalty.

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Rule #5. Annuitize.

At retirement, take a lump sum and with it buy a fixed monthly payment for life. Spread your purchases around, buying at different times (some at age 65, some at 70) and from different insurers (one could go bust). It's a good move, unless your health is bad or you have way more money than you need to live on.

People are reluctant to make the bet. They are afraid they will collect two monthly payments and then get run over by a trolley car.

Take that chance. Tell your heirs.

"Sorry, kids. I'm leaving you just enough for the funeral. But count your blessings. I'm not asking you to pick up my nursing home costs."


 
 

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