I am opening an account with Permanent funds for a mutual fund called Permanent Portfolio (PRPFX).

The fund owns gold, silver, US bonds, swiss francs, and US growth stocks.

The purpose of this fund is to pay down our mortgage. Each year we hope to put in $1000-$3000 in this fund, then somewhere around year 20 of our mortgage, we should be able to cash in the fund and pay off the mortgage.

The fund was chosen because it diversifies what we have now (we do not own 3 of the asset classes the fund holds), it should also have low taxable distribitions (gold and silver do not pay dividends and account for close to 50% of holdings). The fund needs to beat the 5.75% rate on our first mortgage and 7.25% rate we have on our second mortgage. I am anticipating a return of close to 8% per year from this fund.

I have decided to use the self directed brokerage option in my 401k. It costs $20/quarter to maintain, plus transaction costs.

My plan is to put 10k into the self directed brokerage 2X each year. In the 6 months between the brokerage deposits, the money will be invested in my companies normal 401k offerings.

I will track my IRR of both and make sure my choices beat my companies choices.

Company's choices are nameless funds.
43% to domestic large caps
25% to domestic small caps
5% to company stock
15% to foreign developed markets
10% to foreign emerging markets
1% to high yield bond fund
1% to core bond fund

(no mid cap offering)

Brokerage choices will let me do 1/3 aggressive and 2/3 diversified positions.

14% PRPFX (growth)
7% ULPIX (aggressive growth-2X S&P 500)
14% PRFDX (large value diversified)
7% ADVDX (large value dividend accelerator)
10% PRDMX (diversified mid cap)
5% CGMFX (aggressive growth)
10% PRDSX (diversified small cap)
5% xxxxX (aggressive small cap- looking for this now)
20% PSLIX (diversified international)
5% xxxxX (aggressive foreign or global)
3% RPSIX (diversified bond fund)

The bond position will grow 1% from sales of all holdings every 6 months.
I will rebalance 2X per year. In June I will make sure 2/3-1/3 allocation is true. In December I will balance the whole portfolio.

Wife asked earlier in the month about making an extra mortgage payment each year, to pay it off sooner.

I suggested we take the money and invest it as a compromise. In a taxable account which could be used to pay down mortgage if one of us lost a job, or used to payoff mortgage if the money was invested properly.

She agreed to let me invest the $500-$2000 we would pay extra each year. Because the mortgage rate is 5.75%, I think I can pick just about any mutual fund and beat that. My choice is PRPFX- holds some gold, some silver, some bonds, some swiss francs and some stocks. Expecting 7-10% annual returns from Permanent Portfolio.

This was first year I tracked each account, it's value, it's contributions and performance. My 2007 year return was 6.96%.

Ending values for 2007.

Roth IRA me 7.7% return; value $29,133
Rollover IRA-me -2%, value $70,333
401k me 6.7% return; value $41,202
Roth IRA-wife -.88%, value $1,982
Rollover IRA-wife 9.50% return; value $6,870
401k-wife 24.66% return; value $14,165
savings account-both $4000

deposits for 2007:
$4000 savings (this started the EF for us)
my 401k $8575
my Roth $4000
wife's 401k $4338
wife's Roth $2000

We have already added $2400 to savings for 2008. We have already contributed to my Roth for 2008, wife is contributiing prior year to her Roth for Jan-Feb-Mar-April.

Siemens bought out UGS (my employer) in march. Prior to that UGS was owned by EDS. Prior to that SDRC was my employer until that dark day when the CEO sold out and merged us into EDS.

The 401k money prior to UGS has the option of being rolled into Siemens 401k plan, or rolled into an IRA. All UGS 401k money must be merged into Siemens plan. If you ever wondered why the 401k divides money up by "rollover contributions", "employee contributions" and "employer contributions", it because at times like this, you need to know who contributed what.

I chose to rollover the 69k from SDRC/EDS into an IRA with T Rowe Price.

Funds selected:
PRFDX (T Rowe Equity Income) 42%
PRDMX (T Rowe Diversified Mid Cap Growth) 14%
PRDSX ( T Rowe Diversified Small Cap Growth)14%
TRIGX (T Rowe International Growth and Income)14%
PRIDX (T Rowe International Discovery)8%
RPSIX (T Rowe Spectrum Income) 8%

The Siemens plan looks OK... it has one fund for domestic large cap, one fund for domestic small cap, one fund for international large cap, another for international small cap...

but no ticker symbols for any of above... no expense information for any of above... no return history for any of above.

I have a self directed brokerage option for the 401k which I might be considering.

**edit**- chose T Rowe Spectrum Income over New Income. Spectrum income is a fund of funds, which is 75-80% in bonds and cash (other 25% is in PRFDX). Because spectrum income has exposure to high yield and foreign bonds, it's return is higher than most bond funds (8-9% type returns). New Income is one of many bond funds in Spectrum Income.

On June 1 I adjust my contribution percentages to keep 401k in line for next 6 months.

Increased allocation of RYTFX to 11% (was 10%).

Increased allocation of VFINX to 24% (was 23%).

Increased allocation of VEXPX to 11% (was 10%).

Increased allocation of VEXMX to 11% (was 10%).

Decreased allocation of VTRIX to 23% (was 25%)

Decreased allocation of VWNFX to 20% (was 22%).

I also liquidated 1% of each position to bonds. This is the first time I have held bonds in nearly 3 years.

The goal is to maintain the 75/25, 45-15-15-15-10 allocation. The bond position was added, and I rebalance again on Dec 1. Dec 1 I will reset contributions to "normal" levelas and buy/sell to rellocate. If markets trend upward the next 6 months, I will liquidate another 1% to bonds. If markets drop, I will go back to 100% equity.

Looking to get a tally on issues to take care of ro retire early.

1) Health care costs
2) 0 debt
3) saved enough for a 3% initial withdraw rate

other thoughts?

I am going through a refinance right now for first and second on our house. I just ran some numbers and I'd like someone to "check my math". I can send an extra $1250 to mortgage each year (payments of $625 in Nov and Dec) or can invest the same in a taxable account the same two months.

(2nd) Mortgage:

55k, 7.410% apr. 30 yr fixed payment of $382.
-----------

Invest (do not pay off early):

Mortgage payment of $382 for 30 years.
Costs $82,348 in interest payments over 30 years
Costs $1250*28 (first 2 years do not invest the money)= $35,000
"result" is $154,000 in investments after 30 years (plus paid off 2nd mortgage). Assuming 9% rate of return.

Pay down (do not invest until 2nd is paid off):

$625 payment in Nov and Dec each year (except first two years).
Costs $41,208 in interest
Costs $1250*16 yrs of paying down=$20,000
(2nd mortgage paid off in 16 years according to my calculations).
If I invest 12*381+$1250 each year from 16-30 ($5834/year) with same 9% rate of return
"result" is $187,000.

Am I missing something? I was expecting to see the "late investment" not exceed the "invest early".
When I went through same numbers for first, it made sense to invest (much lower APR), but with second I am seeing a different trend.

We are opening a Roth IRA for my wife in may, and we (I) had to go through selecting a mutual fund for her to start with.

I look at our Roth's as "One Entity". My Roth has 30k+ in it, invested in:

PRFDX (~6k) T Rowe Equity Income
PRWCX (~5k) T Rowe Capital Appreciation
RPMGX (~5k) T Rowe Mid Cap Growth
PRNHX (~5k) T Rowe New Horizons
PRIDX (~2k) T Rowe International Discovery
PREMX (~3k) T Rowe Emerging Markets Bond

This is about 45% large cap, 20% mid cap, 10% small cap, 8% International small cap and 17% international bond.

It was obvious to me the hole was "international large cap".

I then looked around for foreign large caps. T Rowe International Growth and Income made the short list. Glanced at two other T Rowe funds (Overseas and Global Stock), along with a few other good International funds (Dodge and Cox).

Dodge and Cox required a $1000 initial deposit with restricted automatic investing, so that "lost" the race with T Rowe. We are sending $300 to open the account and contributing $300/mo to open with Int'l GrIn.

TRIGX was chosen because it follows a good investment philosophy:

"Investment Objective
The fund's objective is long-term growth of capital and reasonable income through investments primarily in common stocks of mature, dividend-paying, non-U.S. companies.

Strategy
Invests in large-capitalization, dividend-paying companies outside the U.S. The stock selection reflects a value orientation. "

Has solid returns over mid term (month end/ quarter end):
1 Year 24.12% 29.92%
3 Years 21.55% 22.79%
5 Years 18.78% 17.93%
10 Years N/A N/A
Since Inception* 10.17% 10.24%
Inception Date December 21, 1998

And reasonable expenses
Expense Ratio As of 10-31-2006 0.91%

I am always interested when people post to discussion groups, asking about "which mutual fund to pick". Helps remind me to think about WHY I picked the funds I did.

Mutual funds in some ways are like shoes. To some people, they only need a few mutual funds and they are happy.

To other people, having many mutual funds is important for one reason or another. And why someone chooses a mutual fund will also change from person to person.

If you need to know, I own more mutual funds than footwear- I THINK. But my wife has more shoes for sure.

The important thing to remember is a mutual fund selection can last a lifetime. I have to buy new footwear once every 3-4 years.

Step 1- know your "asset" allocation and risk tolerance. This means know if you want large caps, small caps, international, bonds, money markets- and/or whatever you want to invest in.

If you don't want to do step 1, then buy a single mutual fund (one size fits all)... either a total stock market index fund or a target retirement fund.

Step 2- plug and play various funds into the asset allocation. Most research suggests return has more to do with the allocation than any specific fund inside the allocation. Meaning you could pikc from any of the 6-7 mutual funds a fund family has for Large Caps, and choose another fund for bonds. The mix of 80%-20% or 50%-50% between these two funds will have more impact on returns than which fund you did or did not pick.

Step 3- if you want to interrogate a fund, I suggest looking at the following criteria:

a) will this fund be held in a taxable or tax advantaged account (IRA's, 529's and 401ks are tax advantaged).
b) what are the top HOLDINGS of the fund.
c) what percent of fund is in top 10 holdings (if 25%, this fund in concentrated, if 10-15%, the fund is diversified). This tells how much risk you are taking with fund compared to similar funds.
d)what is 10 yr and 5 yr history?
e)what are expenses (.75% or less for managed, .15% or less for an index fund).
f) how does fund rank relative to comperable funds?

Next step is use the "calculators" on whichever fund company you choose to determine an allocation. If you want to do a quick one by hand, I created my own calculator below.

The allocation will be % stocks, % bonds, % cash. It will further break this down to % large cap, % small cap, % foreign, etc...

The allocation is "created" based on you honestly answering questions.

Simple questions like:

How long do you have to retire?
If you invested in soemthing and it lost 10% in one year, what would you do? Lost 10% in one day, what would you do?
If you invested in something and it lost 25% in one year, what would you do? Lost 25% in a day what would you do?

The reverse is also useful... 10% yearly gain... 10% daily gain... 25% yearly gain... 25% daily gain.
------------
Here is a simple way to allocate (if you want it)

Start with a

score1 of 0
score2 of 0

score1 is "minimum" % stocks you want.
score2 is "minimum" % bonds you want.


What is your age?
What age do you "expect" to retire? If you do not know, use 68.

What is difference of two above? This is "time".

For each decade in "time", add 20 to your score1. Round up for score one (so 11 rounds up to 2 decades).

If "time" is less than 20, then subtract time from 20. This is score2. Do not round for score 2.

The next step is what "return" do you want.

decide if you want more or less than an 8% return.
for every 2"points" you want above 8% return, add 20 to score 1.
for every 1 point at or below 8%, add 20% to score2


4 examples of calculator:

Ex a) 30 yrs to retirement, want a 10% return.

3 decades*20%=60%
10% return adds another 20%

This situation requires a minimum of 80% equities. How you allocate the other 20% is up to you.

Ex b) 30 yrs to retirement, want a 12% return.

3 decades*20%=60%
12% return adds 40% (4 points above 8% return, 4/2=2*20%=40%)

This situation requires 100% stocks to come close to a 12% return each year. This can be done for short amounts of time, I would not expect 12% returns to sustain over more than a 5-10 year period.

Ex c) 15 yrs to retirement, want an 7% return.

score1: 2 decades*20%=40% minimum equity
score2: time is 20-15=5%, plus 8% return adds 40% more to this (20% for 8% and 20% more for 7%)

So mimumum allocation for this example is 40% equity and 45% bonds. The last 15% can be moved to equities or bonds as you see fit.

Ex d) 15 yrs to retirement, want a 11% return.

score1: 2 decades=40% equity
10% return adds another 20% (within 2 points of 8%)
The additional 1% from 10 to 11 needs another 20% equity.

score1 total is 80% equity.

score2: 20-15=5%. 5% is the minimum amount of bonds.

The conclusions:

The longer you have, the more equities you should hold.
The shorter time you have, the more bonds you should hold. Anything less than 20 years to retirement should have a minimal amount of bonds (with this position growing larger closer to retirement).

If you want more than a 10% return, GOOD LUCK. 8% return is quite doable. 11% is pushing it. Using bonds for anything 8% or less is to increase probability of getting the desired return without adding on too much risk.

Long term return of equities is between 9-10%. There have been 10 year periods where equities have only returned 7%.

Long term returns of bonds is between 4-8%. There are periods where bonds do well for extended periods. It is possible to "time" these periods... entry point will be important (for example right now is a bad period to invest heavily in long term bonds). Low rates, inverted yield curve.

The next step will be dividing equities up to large cap, small cap, international etc...

If you know you want to save for retirement, and know how much you want to set aside, and think you want an 8,9, or 10% return starting now until the daay you retire, you have done 75% of the work.

You have researched "saving", you know you want to invest. The devil is always in the details.

The "last step", IMO, is choosing an asset allocation. The good news is this is flexible. There is not one right answer.

The bad news is this step is quite flexible. "Paralysis by analysis" may result.

Do a little research, make a decision, and use the flexibility to adjust as you learn.

Step 1) Choose a mutual fund company.

suggestions:
a) T Rowe Price
b) Vanguard
c) Fidelity
d) Dodge and Cox

go to the website of each company above and look around. This might be the easiest way to decide.

a) T Rowe Price is best known for their low cost managed funds. T Rowe has been around a long time, and has some mutual funds which are more than 30 years old!

All T Rowe funds are no load. You can open an account in any fund for $0 IF you commit to using the automatic asset builder service (which contributes $50/month minimum).

b) Vanguard is best know an an "index" house. Meaning their "better" funds generally track an index of some type. This yields average performance at a low cost.

The fund "minimums" at Vanguard are much higher than T Rowe. But research this on your own, I only know this based on what I read on discussion groups.

c) Fidelity has the largest offerings of any mutual fund company in the world. Some of it's index funds are cheaper than Vanguards. Some of it's managed funds are more expensive than T Rowe. But if you want a fund which invests in XYZ, more than likley Fidelity has a good choice of how to invest in XYZ.

I do not know fund minimums for Fidelity.

d) Dodge and Cox. D&C is a much smaller version of T Rowe Price, IMO. Managed Value funds which perform quite well.

Fund minimums for an IRA at Dodge and Cox are $1000.

Choosing a fund company has some inertia to it. You can switch houses "anytime", but you might have short term trading fees and more paperwork than if you made a decision based on the fund house.

After creating a "retirement plan", which is built on achieving a certain income level from a certain savings level (see previous blogs for this), a next logical step is measuring if you are "on track".

One technique I use frequently and quicly is the rule of 72. Take the interest rate on an investment. Divide this into 72. The result is the number of years it will take that investment to double.

4 examples
12% interest return. 72/12=6. 12% return takes 6 years to double.
10% return. 72/10=7.2. 10% return takes 7.2 years to double.
9% return. 72/9=8. 9% return takes 8 years to double.
6% return. 72/6=12. 6% return takes 12 years to double.

Backwards check. $100 invested
yr 1 $110
yr 2 $121
yr 3 $133
yr 4 $146
yr 5 $160
yr 6 $176
yr 7 $193
.2 years=$200 (money doubled)


So a way to check retirement. Take the amount needed to retire. If you have not calculated this, use "Current Income/.04" as calculation of what you need. See previous blogs for explanation on this.

My example: Assume you need $1,000,000 ($1 M) saved.

Half this ($500,000) do you have this saved yet?

If not, half it again ($250,000). Do you have this saved yet?

If not half it again ($125,000). Do you have this saved yet?

If not, half it again ($62,500). Do you have this saved yet?

If not half it again ($31,250). Do you have this saved yet?

If not, half it again ($16,625). Do you have this saved yet?

When you do the above, count the number of "halfs" you did. Each time you divided by half, add 8 years to your current age.

This will suggest when you could retire with a 9% return on your investments.

As you save more, especially at younger ages, this equation will look more favorable on your situation.

If you have a retirement plan, and want to check progress, there are many ways to do it.

I am not advocating this as the best way, only way or even a reasonable way... this is something to think about.

When you withdraw money during retirement, there are several forces working "against" you.

1) You are spending money you have saved
2) The markets returns are not predictable
3) inflation can do damage over time even if you account for #1 and #2. Inflation is the "increased cost of goods and serviced". Milk which was once $.99 a gallon now sells for $2.39 a gallon. That's inflation.
4) at some point a person loses their earning power. A person's ability to work and earn more money might be single biggest factor in retiring. If savings tank, and you cannot earn more money, what will you do?

I will use 3 examples of people using different withdraw rates. I will assume all people live 30 years after retiring.

Example A, person has saved $500,000 and withdraws 3% of assets in year 1.

3% of 500k=$15,000.
every year after, this person increases withdraws 3% (to account for inflation).

Assuming a 6% gain each year in retirement, this person would NEVER run out of money. The 3% withdraw rate is quite conservative and each year this person has more money than they had the previous year, except for first two years.

Example B. Person saved $750,000 and withdraws 4.5% of assets. 4.5% of 750k =$33,750. Every year this person increases withdraws 3% (to account for inflation).

Assuming a 6% gain each year. After 30 years, this person has less than half of the $750,000 left. The point being between a withdraw rate of 4.5% and inflation of 3%, the compounding effect will significantly reduce assets.

Example C. Person saved $1 M and withdraws 5% of assets. 5% of $1 M is $50,000. Every year this person increases withdraws 3% to account for inflation.

Assuming a 6% gain each year. In 29 years, this person ran out of money. They spent their entire savings in 29 years.

The risks I am trying to illustrate is what percent can you take out. 4% is usually used as the "planning figure". If you are 30, 20 or even 10 years away, use the 4% number as the target.

There are several things you can do to adjust for withdraws and prevent running out of money in a 30 or 40 year retirement:

1) Only take out the "3% inflation" factor in years market went up (in a down market, keep spending in line with previous year (when market goes down).
2)Purchase an annuity to replace a portion of your "fixed income". The annuity guarantees money for life.
3) Delay SS payments to age 70, to maximaze that benefit, knowing that SS will "never" go away.
4) reduce spending


There are risks with "drawing down" principle, here are risks, not mentioned yet

1) If market drops within first 2-3 years of retirement, this is single biggest risk not mentioned (if market drops 20% in any of above cases, only to "come back in years 5,6,7,8 of retirement, all of situations above would have drastically worse results.

2)High inflation would destroy all of these simulations. I listed example for mild planning, not trying to illustrate what would actually or never happen.

3) Investing to get a 6% return during retirement involves being around 40-60% invested in equities (probably). Getting a 6% return from a conservative investing tool (bonds, money markets, CDs) is not an easy thing to do, and these conservative instruments will lose to inflation most of the time (3% yield from a CD with 4% inflation means you "lost" 1% of money).

One additional point, there is a technique called "Monte Carlo Analysis" which will do most of this for you. Runs through random market patterns, inflation patterns and such to see if "amount", "withdraw rate" and "years to live" last your projected lifetime.

How to create a retirement plan.

Primary question will be "what is your picture of retirement".

Could be "stop living at work and start working at living".
Could be stop doing what pays the bills and start doing what stimulates the brain
Could be to travel the world

Could be combinations of above or things not mentioned.

For this discussion, I will assume you will spend a similar amount of money in retirement as you do while working.

I will assume a person makes $55,000 for this discussion

Objective #1. Determine how much you need.

ex A: If you want to retire early, take your current income and divide by .03. $55,000/.03=$1.84 M. Once you reach $1.84 M in this case, you can retire early.

ex B: If you want to retire in your 60's (closer to standard retirement age), take current income and divide by .04. 55,000/.04=$1.375 M (about 500k less than above).

ex C: If you choose to retire late (past age 70), take current income and divide by .05. $55,000/.05=$1.1 M. 700k less than early retirement.

The point is you can save yourself money by working later in life.

The .03, .04 and .05 is "withdraw rate", which will be discussed later. This % is defined as the % of nest egg you withdraw the first year of retirement. The lower the %, the more conservative the retirement plan.

Objective 2, learn to adjust "what you need". If you can "live on less" in retirement, you can make more assumptions. Live on less because you have a paid off mortgage, you moved to a condo for lower bills, you retired early, but chose a second job to pass time away... these factors allow you to reduce the 55k (used in example above). A traditional assumption is a person can live on 80% of their income in retirement.

so the calculations above:

55000*80%/.03=$1.47M (saved 400k)
55000*80%/.04=$1.1 M (saved 200k)
55000*80%/.05= $880,000 (saved 300k)

Issue 2- saving enough for the "retirement plan".

This depends on current age, retirement age, % of income you save, and how aggressive you invest.

3 examples (all with people either making 55k, or thinking they will be making 55k the year they retire). All examples assume a 10% annual return.

ex 1: A High School student (age 16) making 10k. saves 5% of his earned income in a Roth IRA. Assume this person skips college and works the day they graduate.

5% of 10k=$500.

At age 72, this person has the 1.1 M needed to replace 100% of a 55k income. They saved only $28,500, and have a total savings of $1.1 M

At age 69, the person in this example has enough to replace 80% of 55k.

If you add Social security into this situation, this person could retire in their 60's with their savings replacing 50-60% of income, and SS supplementing the rest.

ex 2: A college graduate which does not start saving until age 25. Make 40k coming out of college. Saves 10% of income (10% of 40k=$4000).

Somewhere between aged 64/65 this person will have enough saved for the early retirement option ($1.8 M).

This person contributed $164,000 to their retirement fund.

ex 3: a couple which did not start saving until their 40's. They make 68k, but have decided they can retire spending only 55k per year (55k is 80% of 68k). They save 20% for retirement once debts are paid off at age 45. 20% of 68k=$13750/year.

Between aged 68 and 69, this family would have saved their goal. ($1.3 M).

They saved $343,000 to reach this goal.

ex 1: set aside 28500 to have $1.1 M
ex 2 set aside $164,000 to have $1.8 M
ex 3 set aside $343,000 to have $1.3 M

ex 1 return (1.1M/28,500)=38X return
ex 2 return (1.8M/164000)=10X return
ex 3 return (1.3M/343000)=3X return

The time one's money was put to work is the biggest factor to achieving goals (this is "the power of compounding"). Time can be overcome with a higher savings rate, or resetting goals "lower" for retirement.

The best retirement "plans", from a financial perspective, are the ones with flexibility. Flexibility comes from account types (and the rules/ advantages of those accounts).

Each account type could be considered "a leg to stand on". The more legs you have, the better.

Every US citizen has the basic leg of social security. The worst case is your retirement savings has only one leg. I consider Social Security to be a "bond like conservative investment". This allows me to invest other areas more aggressively (and take on risk) because I know I have this one leg to fall back on.

The next most common leg is a 401k. The "rules" of the 401k suggest that the withdraws will be taxable. For my wife and I, this means this leg is taxed at 25% or 28% federal tax bracket. Ohio will take some more, we get whats left.

If someone has a pension, that is another leg. I do not have a pension, if I did, I would look at it similar to Social security. It's a conservative tool, so other investments should be more aggressive.

Roth IRAs are another leg to stand on. The rules/advantages of a Roth IRA suggest that qualified withdraws are tax free (YEAH!). Meaning whatever is taken out will not get taxed at all. The more a person can rely on the Roth, IMO, the better. The primary issue here is the only way to get a Roth is to save the money yourself. The above mentioned legs (SS, pension, 401k) get contributions from companies and the government... a Roth needs to funded by the individual which wants to use it.

Annuities are another leg. I see value in supplementing social security with more GUARANTEED income. An annuity is something you "buy" from a life insurance salesman. It is best, IMO, if a person buys an immediate annuity when they retire (and not invest in a variable annuity for 30+ years with high costs). Variable annuities are probably one of worst investments around (for retirement planning), but immediate annuities clearly have a place if someone wants to reduce the risk of running out of assets during their lifetime (the advantage of the right annuity contract would be an income stream for life, none of the other legs, except social security, can offer this feature).

Taxable accounts. If a Roth IRA is maxed ($4000/year for 2007; $5000 a year starting in 2008), a person could invest additional money in a taxable account. Gains in this account would be taxed at 10%/15% long term capital gains rates. This is a lower tax rate than the 401k plan.

The goal is to create as many legs as possible.

Other legs not mentioned including being debt free, owning house (not having a mortgage) and being in good health.

The priority of each leg depends on tax bracket now, tax bracket in retirement, how long you expect to live, and how much money you want to pass onto your kids.

1) Avoid account fees.

T Rowe Price charges $10/year for IRAs under 5k. Each mutual fund is a different "account", so if a person owns 6 fund under 5k, they will be charged $60.

If you ASK, T Rowe will tell you that the $10 fee is waived if you have 10k total in all IRAs.

2) Avoid frequent transactions. If using brokerages (to buy stocks, ETFs or mutual funds from other companies), there is a transaction charge each time you buy or sell. Solution- accumulate money in a savings account all year, then have only 1 purchase transaction per year.

If you get clever, you could save money over 2 years time, and in any of the first 4 months (before April 15), you could buy 8k worth of investment for same transaction cost... making sure 4k gets allocated to prior year and 4k get allocated to current year.

3) Avoid transaction fees on mutual funds. Sme funds charge a "short term" redemption fee. If you rebalance, and need to sell a fund (in a 401k or IRA), make sure you have held the fund long enough to avoid these charges.

If buying mutual funds through a broker, there are frequently 12b-1 fees, sales loads or other charges. This is money out of your pocket. Find no load mutual funds (all T Rowe Price funds are no load).

4) Avoid buying expensive investment products such as variable annuities. If you need an annuity, it is best to invest outside the annuity (in a mutual fund), then sell the mutual fund and buy an immediate annuity. The immediate annuity will have charges, but it's a one time thing when you create the annuity contract, not ongoing fees during the investment phase which drags returns.

If "volatility of returns" is a measure of risk, I can illustrate some examples of why less volatile investments can be quite beneficial.

Assuming a nearly 100% equity portfolio in both cases.

Index

2006 15.64
2005 4.77
2004 10.74
2003 28.50
2002 -22.15
2001 -12.02
2000 -9.06
1999 21.07
1998 28.62
1997 33.19


consider the negative returns (-22%, -12% and -9%) in 3 consecutive years.

$1000 would have shrunk to $900 in 2000. The $900 would have shrunk to $800 the next year. Then shrunk to $620 in 2002.

That is nearly a 40% loss over 3 years. Quite volatile (relative to highs of 28-33% 3 times)

Choosing a fund which is 100% stock, but managed (so as to prevent steep losses).

returns of

2006 19.14
2005 4.26
2004 15.05
2003 25.78
2002 -13.04
2001 1.64
2000 13.12
1999 3.82
1998 9.23
1997 28.82

$1000 in 2000 would have increased to $1130 in 2000, to $1140 in 2001, then dropped to $993 in 2002. By not having the negatives, it can maintain princpal balance and still be 100% stock.

The reason for the difference in returns is the managed fund would NOT hold stocks which did not have good prospects on the way down, as well as the managed fund can buy stocks because their valuations look "cheap" based on recent stock events.

It does cost more money to not lose as much... keep in mind all returns listed (by law) are net of expenses... so the expenses are factored into the above returns.

My point is that indexing has downside risk. it is possible to invest in a portion of the index, with less risk and higher expense, and approach the returns of the index.

Over the 10 years listed above the top fund (VFINX) returned 7.55% with a high year of 33% in 1997 and low of -22% in 2002.

Over the 10 years listed, the second fund (PRFDX) returned 9.61% with a high year of 28% in 1997 and low year of -13% in 2002.

Other funds with similar styles to PRFDX (conservative equity investing, but nearly 100% equity):

DODGX (Dodge and Cox stock)
FEQTX (Fidelity Equity Income)

Examples like these are another example of being 100% stock and having less risk than someone which might be 80-20.

Downward risk/ defensive investing is a long time strategy which works for many people.

Risk is defined as various things.

To some it's loss of principal.
To some it's "change" in principal (volatility)
to some it's variance of returns
to some it's variance of expected return.
to some it's the cost of investing (cost of mutual funds).
to some the time something is invested is a risk (time)

inflation is a risk as well meaning if someone avoided the risks above, their risk just changed to inflation eating away their returns from bonds/cash.

In the lengthy discussions on indexing yesterday, many people cited cost as a risk (meaning my funds were more expensive and posed a risk to making money).

My view of risk is volatility of returns (especially negative returns).

If someone takes on more risk, they should be rewarded with more gains (given enough time).

Indexing by definition is risky. There is inherent volatility within indexes. Returns vary significantly (10% average with a range of -25% to +33% for last 10 years). Highly volatile. The issue with volatility/risk is it takes more time (adds another factor into risk) to recover the losses.

I will list an example later.

Costs do not indicate risk or performance. Costs are part of equation (all things being equal, lower cost has better return). What smart fund managers do is manage risk as much as they pick stocks. This risk could be managed by going to cash, could be timing buys at low points of market, could be avoiding bad investments all together. The reduction of risk "has a cost", and if the reduction of risk yields positive returns when an index is going down, then the additional expense (to me) is well worth the cost.

indexing works GREAT in up markets, and performance will be better than strategy I am suggesting (defensive equity funds). These gains reward the indexer which took the ride down.

A discussion yesterday on "indexing" a way of investing meant to minimze fees and give an investor the return of a given index deserves a discussion.

Issue 1, investing is NOT a religion... yet some people swear by indexing more than they go to church.

Issue 2, make sure you understand the index (NEVER invest in something you don't understand). The popular indexes used are S&P 500 (large cap stocks), Wilshire 5000 (the top "5000" companies in the country), the Wilshire 4500 (the top "4500" companies with EXCEPTION of the top 500-S&P 500), and the Russell 2000 ("2000" small companies).

Issue 3 managed funds will compare themselves to an appropriate index. Fees matter. Some managed funds charge .69% (T Rowe Equity Income) and .73% (T Rowe Captial Appreciation)expense ratios. Index funds charge ~.35% (TRP equity index) to .18% (Vanguard Index 500) to .07% (Fidelity Spartan 500).

Issue 4. RISK. Risk can be defined as volatility- the liklhood returns will vary significantly. If a person accepts risk, they are accepting variance of returns. If a person wants less risk, they are usually willing to sacrafice the high end to avoid the low end.
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I want to combine these issues, concetrating on S&P 500, the most popular index.

Do you know why a company is in the S&P 500? If you believe investing in only things you understand, but cannot answer this question, it appears you do not practice what you preach.

My understanding is a group of people which work for "standard and poors" (S&P) decide the 500 companies which are proxies for the whole market. Not the 500 largest, not the 500 fastest growing, not the 500 best values, but some random group of 500 stocks.

The index does change year over year. Companies get dropped and added as S&P people see fit. These people at S&P have no vested interest in anyone in an index fund making money.

Most S&P 500 index funds own all 500 stocks in the index. The mutual fund is broadly diversified (owns 500 stocks, most managed funds own 100-200 stocks). They own the bad ones (like Enron), they own companies in bankruptcy (like Dana, Xerox, Ford, GM) until the companies are removed from the index.

This is "downside" risk. If a person owns an index fund, they own these companies "on their way down", with no mechanism to dump the losers.


It gets much more cloudy with Wilshire 5000. For one thing, the Wilshire 5000 index has more than 5000 stocks in it. WHAT? Yes, it has ~5700 stocks in it last I looked. Second is a Wilshire 5000 index fund will NOT own all "5000" stocks. It will own a SAMPLE of the 5000 stocks. Index has 5700 and fund owns less than 5000. WHAT GIVES?

Two problems with this. First is if index has more the 5700 companies, couldn't the people creating the index make a decision as to what to remove? Second if the fund manager now has to make a decision as to what he does or does not buy (he cannot buy 5700 stocks, it would be WAY too costly), what does he decide to buy and WHY. Why is not listed in fund prospectus. Invest in what you understand.

So in reality a wilshire 5000, wilshire 4500 or russel 2000 index fund is being "managed", a person is choosing what stocks in the index to put into the fund which is owned by a customer.

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Control and Accountability. Those are probably two words most people want in most things in life.

This is why I choose managed funds. My fund manager is accountable to me. I have control over the types of companies I invest in based on the fund manager I choose.

The risk of a managed fund is if the manager misses a "good stock" on it's way up. The advantage of a managed fund is the fund manager does not have to ride a stock on it's way down.

Xerox is a good example. it was a high flying stock in the 90's. High dividend, high yield. excellent performance. I used to work for Xerox, and also owned the stock (XRX). My father even retired from Xerox. Then speculation started about bankruptcy. Any managed fund in their right mind dropped the stock like a bad habit. price dropped. Then Xerox filed for bankruptcy. Stock dropped again and removed it's dividend (Xerox had previously reduced it's dividend prior to this when bankruptcy speculation started). An index owned the stock all the way down. Xerox is still part of S&P 500... so it brought the return down... where as most managed funds probably sold it.

The goal of managed funds is to reduce risk by not taking the ride down.

The examples I like to use are PRFDX and PRWCX. I will compare to VFINX (Vanguard 500 index, largest mutual fund in the world, I think).

PRFDX is T Rowe Price Equity Income
PRWCX is T Rowe Price Capital Appreciation


PRFDX expense ratio is .69%
PRWCX expense ratio is .73%
VFINX expense ratio is .18%

The question is, does .5% expenses get an investor out of the down cycle?

PRFDX returns

1997 28.82%
1998 9.23%
1999 3.82%
2000 13.12%
2001 1.64%
2002 -13.04%
2003 25.78%
2004 15.05%
2005 4.26%
2006 19.14%

PRWCX returns
1997 16.20%
1998 5.77%
1999 7.07%
2000 22.17%
2001 10.26%
2002 0.54%
2003 25.47%
2004 15.29%
2005 6.85%
2006 14.54%

VFINX returns
Year VFINX Category Diff
1997 33.19
1998 28.62
1999 21.07
2000 -9.06
2001 -12.02
2002 -22.15
2003 28.50
2004 10.74
2005 4.77
2006 15.64

note that 10 yr returns for each fund are
PRFDX 9.99%
PRWCX 12.26%
VFINX 7.55%

It's cool the two funds I mentioned beat the index, that was NOT the goal. The goal was an 8% return (which both exceeded) WITHOUT THE RISK. Look at the lows.

2001 and 2002 in particular. 2005 as well. The goal is to reduce risk, not beat the index. Beating the index is a measurement (if returns were significantly lower than the index, one could argue that less risk yielded a much lower return).

I will post a blog on risk tommorrow.

There were 2-3 different "allocation" discussions yesterday. One person at 85-15 equities/bonds, another person switching from 60-40 to 70-30.

This allocation only explains a BRIEF amount of the risk you take. A third person posted a link to a web site which suggested the "equity" position determined **most** of the risk a person takes.

This does not give the full story.

If you put 100% of investments into S&P 500 you are taking on way too much risk. All eggs are in one basket analagy. You will probably "beat" inflation by 5-7%, with a fun roller coaster ride on a day like yesterday.

If you put 100% of investments into bonds (bond index, for example), you have all your eggs in a different basket. Your risk is now centered on interest rates, when rates go up, you will probably lose money, (as rates increase, bond prices drop) and you will only beat inflation by 2-4%... probably.

If a person was 85-15. All 85% in S&P 500, all 15% in bond index, they have less risk than a person with 100% in either or, and the returns would probably be ~8-9% annually (beating inflation by ~5-6%).

If the same 85-15 person took the 85% and divided it amongst S&P 500, large cap value, International, small caps and mid caps, then took the 15% and divided it among REITS, short term bonds and money markets, they would have less risk than any of the previosly mentioned cases.

Which takes me to another point. A person can invest in 100% equities, be divided among large, mid, small and international stocks (funds) and have LESS risk than a person doing 60-40 with only 2-3 funds.

If the person doing 100% equities has TIME, the time reduces the risk they take (they have time to rebound from a day like yesterday).

I don't want to tell anyone to go 100% equity (I am 100% equity), but it's possible the person doing 100% is taking on less risk than the investor which uses only 2-3 funds.

Porfolio allocation helps reduce risk. Time helps reduce risk. Once retired, you no longer have the time to earn back losses, so the risk of retirement funds running out rests squarely on allocation.

Risk (to me) is defined as maintainance of principal balance. I do not want to see account worth $1.5 M in year 1, only to lose 33% and be worth $1 M a year later (even if it could also be worth $2 M a year later).

At retirement I plan to have positions in:

Cash/Bonds (25%)
Large Cap Value (20%)/45
Large Cap Growth (10%)/55
Mid Cap Growth (7%)/62
Mid Cap Value (7%)/69
Small Cap Growth (5%)/74
Small Cap Value (5%)/79
International Large Cap (15%)/94
International small cap (6%)/100

The longer one could keep an allocation like this, the better they will be. As previously stated, the 25% cash and bonds is a retirement position, with ~7 years worth of income. As this gets spend, the portfolio will become "riskier" as cash is reduced. Riskier might become as much as 85%/15% Equity to cash mix.

The way to reduce this risk is to sell off the sections with highest volatility (volatility is change of principal balance). So the International Small Cap and Domestic Small cap positions will be eliminated first.

Then the mid cap positions get reduced.
Then the international large cap positions get reduced.

To point where a 60-40 portfolio looks like:

40% cash/bonds
20% large cap value
10% large cap growth
10% mid/small cap
20% international

The biggest risk to retirement savings is a down year in the stock market within the first 3-4 years of being retired. I believe I read that on a web site (like T Rowe Price). My plan is to hedge this risk with cash.

Issue 1: determine income needed. I like to use 80k as an example.

Issue 2: total porfolio size needs to allow for 4% withdraws. 4% is the most common withdraw percentage used at websites like Vanguard and T Rowe Price. 80/4%=$2 M saved.

Issue 3: Hedge against a down market by putting 7 years in cash instruments. CDs, money markets, I-bonds, bond funds.

7*80k=560k. Meaning I am suggesing 560k of the $2M be put in cash (25% CASH). If a portion of this cash allocation can come from money outside the 401k/Roth IRA accounts, this improves the situation. The remaining $1.5 M is invested in equities (so allocation is about 75% equity and 25% cash/bond)

This is done in the year prior to retiring.

80k in a 1 yr CD (this is next year's income)
80k in a 2 yr CD (this is year two's income)
80k in a 3 yr CD (this is year 3's income)
Put 240k in I bonds. The biggest risk to cash investments is inflation. If inflation hits in next 3 years, you want to hedge this risk with I bonds (or other inflation indexed securities).

The last 80k is flexible. A bond fund, dividend paying stocks or Real estate is my suggestion.

Each year take 1/3 of the I Bonds and convert to a 3 yr CD. This is the income you will spend 3 years later. This system is a 3 yr CD ladder with 6 yrs worth of cash and 7 yrs worth of conservative investments.

Each year take the same amount out of 1.5M invested in market and put into I-bonds.

This automatically increases withdraws in line with inflation (The I-bonds calculate this for you).

The 1.5 M invested needs to generate a 5.3% return to create 80k. It is possible the 1.5M could sustain itself and grow the next 10 years (meaning 1.5 M could swell back to ~$2 M) depending on the market.

The rule I plan to follow is only withdraw 80k in an up year. The next 6 years income is already established. If account increases 8%, 5.3% is put to cash and the other 2.7% is left invested in the market.

Another issue to recognize is as cash is spent down, your risk is increasing (75% equity/25% cash in year 1 might become 80% equity/20% cash by year 3,5 or 7).

To hedge this risk, recognize any of the following:

6 years income was put in cash. That 7th yr is flexible depending on risks investor wants to take, tax law (maybe something presents itself to you), and by yr 5, it's clear to me that will need to be in cash, but maybe yrs 1-4 generate enough dividends to supplement income another way.

Allocating the retirement equity positions will be the next subject.

Generally speaking, you need to save an amount equal to your current income/.04.

If you make $80k per year, divide this by 4% (.04), the result comes out to $2 M.

This $2 M could come from many places

1) SS
2) 401k
3) IRA (Roth preferred)
4) taxable accounts
5) downsizing house to a condo (might create ~150k-200k)

SS:
Of the 80k per year needed, SS might generate around 24k of this. More than likely the SS income would be taxed. (80k is a "significant" income and depending on age, it could be assumed anyone with a significant income in retirement will be subject to SS payments getting taxed).

401k. 401k withdraws will be taxed. 80k is currently in thr 25% tax bracket. meaning tax paid is $8735 (tax owed in 10% and 15% tax brackets, up to $63,000)+ 80,000-63,000=17000*25% is $4250. Federal tax owed each year would be $9285 (there is now 71k you have to pay state taxes and other expenses with).

Roth IRA withdraws are "tax free". If you withdraw 80k from a Roth, you owe no taxes on it. This is why a Roth is the prefferred mechanism for funding retirement, IMO.

Taxable accounts. If you withdraw 80k from a taxable account, you will only owe taxes on the gain (when you sell). If you purchased a security for 20k and sold it for 80k, you have a "capital gain" of 60k. 60k would be taxed at 15% which is $9000 (this is less tax than you paid on same 80k withdrawn from 401k). The 60k gain assumed here is conservative (most gains would be much less than 60k).

So the question remains- which account should you use to fund retirement?

I suggest all types. Contribute to a 401k. It will lower your current tax bill. Because SS still exists, invest the 401k aggressively. Worst case is you collect SS and treat SS like a bond/cash/ annuity type instrument if aggressive investing fails.

A Roth account is the "denser" than any other account. it costs more to put money in a Roth today (because the money going in is taxed before going in). But the tax free withdraws coming out are a key component to retirement income planning.

Taxable accounts. If you become ineligible for a Roth contribution (income greater than 150k for married couples, I believe), then use taxable accounts to allow for cheaper capital gains tax rates in retirement. Taxable accounts should consider using individual stocks as opposed to mutual funds (to avoid intermediate capital gains taxes while accumulating assetts).

Downsize the house if it makes sense. This might reduce the 80k income needed to 75k (lower utilities, property taxes) and create an extra 150k or so you could invest in a taxable account.

I have a chart I use to track retirement savings. It can be easily created in excel.

top row is return percentage (before inflation.

row 1

Column C is 6%
Column E is 7%
Column G is 8%
Column I is 9%
Column K is 10%
Column M is 11%
Column O is 12%

row 2
row underneath is "years to double". 72/%
C=12 (72/6=12)
repeat forumula C2:I2

in cell B3 type in retirement age (68 for me).
in cell C3 type in your income/.04. (80,000/.04) for me= 2,000,000

this means the retirement goal is 2,000,000 at age 68.

in cell B4, subtract C2 from age
in cell C4 divide C3 by 2

meaning X years to double needs half the amount.

repeat. in B5, Subtract C2 years from age in B4. repeat this formula down. In C5, divide C4 by 2. Repeat this formula down.

Columns B and C show age check points for a 6% (conservative) return. If you meet any of the age/amount goals at a young age, you will have smooth sailing to retirement (and could probably retire early).

Repeat this for other return amounts. The goal is to be as far left as young as possible.

For a 12% return, I would be putting 30% in small caps and 50% in international stocks... by 10% I would be much more conventional (40%+ in domestic large caps for example). For 7% return, I would start owning bonds (to preserve amount already accumulated).

Two words "equity income". If you had to choose one mutual fund in your 401k, my suggestion would be either a retirment date fund or an "equity income" fund.

I own T Rowe Price Equity Income (PRFDX) in my Roth IRA and Vanguard Windsor II (VWNFX) in my 401k. My wife has ACGIX in her 401k. All 3 are equity income (large cap value) mutual funds.

Large Cap Value tends to have best returns over time, and is why I make that suggestion.

I believe in assett allocation to reduce risk. As a 34 yo (wife is 33) our target allocation is:

45% domestic large cap
15% domestic mid cap
15% domestic small cap
15% International Large Cap
10% International small cap

This allocation is 75% domestic, 25% international. It is 100% equity "in theory".

For my Roth IRA, I own:

PRFDX (domestic large cap)
PRWCX (domestic mid/large cap value)
RPMGX (domestic Mid Cap)
PRNHX (domestic small cap)
PRIDX (International small cap)
PREDX (junk bonds, emerging market bonds)

My wife's Roth IRA will be

TRIGX (International Large Cap)

as you might see, I prefer T Rowe Price. Low cost funds (all no load), excellent customer service, and offerings in every asset class.

In my 401k, I own:
VFINX (Vanguard 500 index) 20% large cap
VWNFX (Vanguard Windsor II) 25% large cap
VEXMX (Vanguard Explorer) 10% small cap
VEXPX (Vanguard Extended Market Index) 10% mid/small cap
RYTFX 14.30 +0.11 (Royce Total Return) 10% small/micro cap
VTRIX (Vanguard International Value) 25%


In my wife's 401k, we own:

REREX International Large Cap 25%
RGAEX Domestic Large Cap 20%
ACGIX Domestic Large Cap 25%
SSVSX Domestic Mid Cap 20%

we also own 10% company stock in her 401k.

We duplicate allocations, with IRS's being the "core". As we change jobs, we don't have to repick funds, just pick the best 401k funds to meet part of this allocation. If in doubt, we overweight large cap value (if no better 401k choices exist).

I contribute 10% to 401k (increases 1% each year automatically)
Wife contributes 6% to her 401k.
I max out my Roth (4k each year)
2007 will be first year my wife has a Roth IRA.

Be good at what you do. Most people which are financially successful are not successful simply because they saved and/or invested.

They are good at what they do, first and foremost. They then take a portion of what they make and set it aside.

My suggestion is to save 10% into a 401k or similar plan. This makes retirement savings easier (you will need less because you trained yourself to live on less).

If you can save more than 10%, GREAT, but any realistic savings plan needs to account for at least 10% of gross pay.

The more you make, the higher this percentage needs to be, 10% is the base amount for starters.