Invest for Targeted & Consistent Retirement Savings Returns
8 Rules for Targeted and Consistent Retirement Investment Returns
A critical input that drives all retirement calculations is the estimated return on your retirement assets.
Guess too high and you won’t have as much saved for retirement as you need.
Guess too low and your retirement balance will pleasantly surprise you. But you might otherwise delay a retirement that you could have enjoyed earlier, and wasted worry in the meantime that you were falling short of what you needed.
In addition to the rate of return on your retirement savings, there’s a second related factor that’s often overlooked, and it can be even more important.
Consistency is critical because it leads to peace of mind, and increases your chances for hitting the targets in your retirement plan.
Rapid year-to-year swings in returns can undermine your confidence that your investment approach will enable you to reach your retirement goals.
One year you may hit or even exceed your savings balance target, only to go on to miss it for the next few years.
Inconsistency can also tempt you to make knee-jerk changes to your investment mix, often at the worst possible time.
To ensure both peace-of-mind during your pre-retirement years and a secure retirement, it’s essential to deliver returns that are close to your targeted returns AND relatively consistent.
We believe there are 8 rules to help you invest for targeted and consistent returns:
- Fund your plan in the prescribed mix
- Assume more risk early on, less later
- Don’t get paralyzed by the paradox of choice
- Keep it simple unless you are an advanced investor
- Get advice from a fee-only financial planner
- NEVER swing for the fences
- Completely risk free is too risky
- Fees matter a whole lot
FUND YOUR PLAN IN THE PRESCRIBED MIX
A key input is the projected rate of return on your retirement savings.
Driving that rate of return is an anticipated mix of investments generating combined expected returns on those investments.
Estimates are typically based on historical returns for the asset type(s) you’re considering, with higher risk usually tied to a higher expected rate of return.
Once you’ve carefully considered your income needs, expected savings, projected rates of return, and tolerance for risk, you will lock in your investment mix.
One of the biggest mistakes in retirement preparation is to deviate from the investment mix you’ve chosen, yet hope to still hit the returns projected in your original plan.
Making thoughtful, occasional investment adjustments based on new information or a change in risk tolerance is smart, provided calculations are adjusted to reflect changes in the projected rate of return.
But arbitrary and frequent changes in investment mix can outright invalidate the foundation upon which a retirement plan is based.
Sudden changes in mix are often prompted by a few key events. First and most common is a market downturn.
During the market collapse of 2009, 3 in 10 retirees pulled money out of the market in an effort to avoid further losses.
Those who held throughout the drop, only to sell at the bottom, destroyed their retirement plans. Retirees who waited it out would have likely recovered their losses, and swung to a gain within three years.
The key to successful wealth accumulation is to learn from others’ mistakes. The learning here is to avoid fear-driven reactions to fluctuations in the market.
Either assume an active investor approach where you make adjustments based on carefully set rules, or resolve to ride out fluctuations. Whichever you choose, decide in advance so you don’t become a victim of your emotions.
Pick your investment mix strategy and stick with it. Any changes to your approach should be deliberate, rare, and well-thought.
ASSUME MORE RISK EARLY ON, LESS LATER
Taking on a level of risk consistent with your tolerance and desired returns is foundational to intelligent investing.
Some financial experts may advocate you push well outside of your comfort zone, but we disagree. If your investments keep you up at night, you are depriving yourself of one of the biggest rewards of building wealth: peace of mind.
Of course if you are unwilling to accept any risk of loss of capital, you have to also build your plan around much lower returns – or even no returns, as was experienced by many as the Fed drove rates to near zero and has maintained them for nearly a decade.
The right risk level is unique to you, and is often based on your current level of wealth, investing experience, stage of life, and income level, as well as other factors.
It does pay to accept as much risk as you feel comfortable with so that you can pursue a higher return. But it’s also important that you not cross over to reckless risk, regardless of your confidence level.
Most important is that your risk profile evolve over time.
When you’re decades away from retirement you have plenty of time to ride out market fluctuations and recover from losses.
Closer to retirement, a large drop in your principal is catastrophic.
Target date retirement funds are structured to reduce your risk profile as you get closer to retirement. You can also achieve this strategy on your own.
For guidance, you can read the prospectus of target date funds to gain insight on how they manage reducing risk through an evolving investment mix.
Another approach is to do your own research to gain knowledge on the ideal asset classes for retirement funds.
However you achieve it, it’s critical to preserve your principal as you reach retirement. When you’re close to your big day, you simply run out of time to bounce back from nasty dips.
There were far too many hopeful retirees forced to work well beyond their projected retirement dates due to the 2008 downturn.
Unfortunately, I know one senior executive who had an ideal retirement planned and funded but lost most of his retirement savings by selling at the bottom. This forced him work well beyond what he wanted.
He was miserable and filled with regret, and his perpetually bitter attitude compromised his business decisions and the attitudes of those who were forced to work with him. A real lose-lose situation.
Don’t allow yourself become one of those victims.
DON’T GET PARALYZED BY THE PARADOX OF CHOICE
Especially for a new investor, the investment choices available in some company-sponsored 401k plans can be overwhelming. Some get paralyzed by the paradox of choice and, as a result, take no action or the wrong action, engaging in either too much or too little risk.
While not the perfect solution for all, target date funds can be an option that cuts through the confusion of too many options. Before you choose one, however, check out the investment fees. The lower cost funds carry expenses on average of 0.50%. If the fee is higher than that, you’re wise to consider other options.
Many employer plans now also include the opportunity to invest in ETFs that track the broad markets. ETFs can be a low-fee alternative to mutual funds that carry higher fees.
ETFs that track broad market indices like SPY, DIA, or QQQQ will allow you to get very close to the same performance as the overall market it tracks.
This is referred to as buying the market, which allows you to participate in broad market moves, while being insulated from the risk of single stocks or sectors.
Buying the market, provided it’s an entire large index like the DOW, S&P500 or Russell 5000, provides some level of diversification. NASDAQ, for instance, provides diversification within the tech sector, but its basket of stocks are primarily tech.
While target date funds and broad market ETFs are two simple ways to easily overcome the paradox of choice, the third alternative is to get professional guidance on your investment mix.
This can be achieved by working with a fee-only advisor external to your retirement plan. While this requires the investment of their fee, you can limit costs with one consultation when you first set up your plan, and then get updates at three to five year intervals.
A solid retirement plan should stand the test of time and not require constant review.
Another alternative, often available for 0.75% or less of your assets, is to work with an advisor who is part of your company-sponsored plan.
Just be sure to understand whether or not they’re receiving commission for certain investment suggestions, as this may compromise their objectivity.
The bottom line is that you should never let the paradox of choice get in the way of moving forward with making the investments that will allow you to bring your retirement dreams into reality.
KEEP IT SIMPLE UNLESS YOU ARE AN ADVANCED INVESTOR
Investment complexity often leads to confusion and subpar returns. Complexity can occur in several forms.
One is spreading your money across too many investments, thinking you’re diversifying your risk. Often that’s not the case because some ETFs or mutual funds you’re holding may have overlap as they’re in the same sectors, or even the same stocks.
Too many investments also can cause difficulty in keeping track of performance, so you may have perpetual losers you keep holding because they get lost in the shuffle.
Another form of complexity is simply not having a full understanding of what you’re buying.
This is less likely in company sponsored plans as they often stick to the well-know investments, but it’s more likely to occur in self-directed IRA brokerage accounts where the options are massive.
For instance, the average investor may find the risks and dynamics of some ETFs difficult to fully understand. One example is commodity ETFs that track oil.
An investor may believe that a fund will perfectly track price changes of the widely quoted price of crude.
While this may be accurate in the very short term, the reality is that it may deviate widely over time because most funds are moving in and out of futures spanning several months. These contracts may have a substantially different spot price than a near month contract that’s typically quoted as the ‘price’ of oil.
This could lead to a situation where the underlying price of oil is flat over a 12 month period, yet the ETF investor experiences a significant loss.
Specialty ETFs, as well as many other more exotic investments, can be powerful wealth-building tools. Just be sure to fully understand where you’re placing your hard-earned money.
Unnecessary investment complexity, as well as investing in investments beyond their understanding, were key factors in my aunt and uncle’s retirement disaster story. Keep things as simple and understandable as possible.
GET ADVICE FROM A FEE-ONLY FINANCIAL PLANNER
As discussed in breaking through the paradox of choice, a fee-only financial planner can be valuable in setting and periodically affirming or adjusting your investment mix.
This topic deserves its own section, however, to emphasize the importance of selecting a fee-only planner.
Many retirement planners will avoid fee-only planners because it requires an out-of-pocket cost. But this expense really should be considered an investment.
As logical as we believe we can be, especially when it comes to investing, humans are emotional creatures. Which means we are not objective.
There are no do-overs when it comes to preparing for retirement. Every year counts because it’s a year you can’t get back.
Therefore it can be advantageous to get an occasional outside, objective opinion on your retirement investment mix. The best timing is when you’re first setting up your plan and mix, when you are considering major shifts in investments, and at three to five year intervals even if you’ve changed nothing.
Beyond ensuring the right investments to meet your objectives, outside advice can help keep you accountable to your plan.
Even though you’re the customer in hiring a fee-only financial planner, knowing that someone will review and evaluate your activity can increase the likelihood of sticking to the plan because you now have a person to ‘answer’ to.
A third area where a planner can be a wise investment is if you and your significant other are not fully aligned on your investment mix and / or overall retirement plan.
Sometimes spouses simply can’t come to agreement. Realities like large differences in risk tolerance, expected retirement planning, or spend vs. save mentality, can sink the best of retirement intentions.
An outside planner can be an objective and non-emotional source of reality, so that both partners can find a way to agree as they both occupy the same financial lifeboat.
The one type of advice to fervently avoid is the financial planner-sponsored free dinner. There is no free dinner in life, and these types of gatherings are the best example of that truth.
The sponsors often work on commission for whatever solution they are pitching. In order to finance the dinner they need to sign new clients. It’s that simple.
My aunt an uncle attended many such free dinners as they searched for free financial advice after they destroyed their portfolio.
It’s at such a dinner they were sold into a terrible annuity and a trust they neither used nor activated.
A free financial seminar dinner might be the most expensive food you’ve ever eaten. It was for them. If you’re tempted, just stay away. Your financial future depends on it!
NEVER SWING FOR THE FENCES
Swinging for the fences is a baseball metaphor which means intentionally trying to hit a home run. It often happens when your team is down and desperate.
This also applies to investing. One may be tempted to do this to make back a large loss, or when they’re way behind in preparing for retirement and time is running out.
Taking a massive risk by ‘betting’ most or all of your retirement savings on a single high-risk investment rarely works.
I know that reality all too well. As a young twentysomething investor, I did just that with my brokerage account. I put my money into what was a sure-thing gold mining stock and blew up a sizable brokerage account.
My reasoning for taking such a large risk with a single investment is that I was young, had plenty of time to make up a loss, and I wanted that home run return.
It didn’t work out and taught me an important, life-long lesson. When your investing is more like betting, it rarely works out. It certainly didn’t for me.
Beyond recognizing the perils of swing-for-the-fence investment decisions, the most important step you can take to avoid it is to eliminate the underlying motivations.
If you begin preparing for retirement as soon as possible, saving early and automatically, you will gain the peace of mind of knowing you’re going to reach your retirement targets.
And if you set your investment mix in a way to reach consistent and targeted returns, you won’t be tempted to quickly make up lost ground.
The final problem with the swing for the fences approach is that it occasionally works. Yes, believe it or not, that can be a major problem.
Because the temptation really spikes to do it again. And the chances of a long shot coming in twice or more is extraordinarily small.
In retirement planning and saving, slow and steady really does win the race.
COMPLETELY RISK FREE IS TOO RISKY
Almost as dangerous as too much risk is too little risk. Of course all sane investors hate to put their savings at a risk of loss.
The problem is that zero risk typically produces very low returns, and those returns often lag the underlying inflation rate.
Which means you end up falling behind in being prepared the inflation that’s likely to erode your retirement savings.
The right move is to take a balanced approach between risk and returns, and tilt that balance to less risk as you approach retirement.
No one likes to lose money, but here’s where time is really on your side.
When you begin saving for retirement decades ahead of your big day, you possess the power to ride out the inevitable fluctuations in the investment markets, especially with stocks.
Even during the stock market plunge of the great recession, if you were in an S&P index ETF with low expenses, and if you had gotten in at the peak and held through the valley without selling, within 3 years you would have recouped all of your losses and swung to a gain.
You would have done even better if you continued to methodically buy at bargain prices as the market sank and then recovered.
The broad markets will fluctuate and it can be sickening. But over decades long horizons, you would have still made money.
There’s no guarantee this action will repeat, but the alternative is to place your money in no risk investments, with the guarantee that the buying power of your money will be slowly washed away by inflation.
Risk free is simply too risky for retirement preparation. Work to find your right balance.
FEES MATTER A WHOLE LOT
Retirement preparation is a long-term pursuit. Time helps you gradually save and prepare, and it unlocks the awesome power of compound interest.
But time does have one nasty characteristic: it allows investment fees to compound and erode your retirement savings.
A few percentage points don’t seem like a big thing, especially in those great years when your returns are 7%, 8%, or more.
But even an extra unnecessary 1% fee in expenses, just like the interest you earn, compounds over time. But instead of helping you, it erodes your cash.
And as your portfolio grows, 1% can add up to a large real-dollar amount. For instance, if you have a retirement savings account that averages a balance of $500,000 over 20 years, 1% adds up $100,000 over 20 years.
And it’s a double negative. Not only are those dollars gone, but so are the interest earnings that the destroyed dollars would have produced.
So how do you neutralize the drain of fees?
First, it starts with understanding your objectives during high level retirement planning. Then, as you select your investment mix, shop for the alternatives most likely to hit your projections with the lowest fees.
Many ETFs that track broad markets and large sectors can be found with low fees. This makes sense because these funds require little management oversight as they simply mimic already established baskets of investments.
Even with broad market ETFs, careful shopping pays off because there can be a substantial spread from the least to the most expensive.
Also pay attention to plan administration fees. Most employers who sponsor a retirement investment plan charge low or no administration fees to the employees.
But that doesn’t mean that the investments available within the plan are necessarily all low fee.
The bottom line is that fees can negatively affect your retirement savings in a big way. Guard your bottom line carefully, and your savings balance on retirement day (and after) will thank you.
When you invest for targeted and consistent returns, you dramatically increase your chances of securing both retirement you deserve, and the deep peace of mind that brings.