GROUPIRA Learning Center

Education, strategies, and tools for our Members to invest better for whatever comes next in life.

Does Your Investment Strategy Work for You?

A common frustration of the financial services industry is the use of jargon that confuses people. An investor’s “asset allocation strategy,” is one example of financial services industry jargon. In simple terms, an asset allocation strategy answers the question: How do I invest my account balance? There are good and bad asset allocation strategies. The best strategies accomplish two things:

  • diversify investments, to reduce risk
  • provide suitable investment return potential, relative to your personal situation

Risk means the possibility of losing principal -- the amount you invest. Every investment has risk. Even keeping money in a bank account has risk. How? If your bank fails, and the U.S. Government does not guarantee your entire account balance, you may lose your money.

However, not taking suitable risk can be just as bad. Why? Over time, money loses purchasing power because the costs of goods and services generally rises. This effect is known as inflation. We see inflation everywhere. Inflation is why a can of Coca-Cola cost $0.05 in 1950 and about $1.00 today. If your investment returns exceed inflation, then your purchasing power increases over time.

There are many ways to measure inflation, but a good estimate is the U.S. Consumer Price Index. Historically, the average annual change in the U.S. Consumer Price Index has been slightly more than 3%. This means that if a can of Coca-Cola cost $1.00 today, we could reasonably expect it to cost $1.03 one year from now.

Investments with greater risk tend to provide greater investment return potential. Equity investments (ex. stocks and stock funds) provide the greatest return potential, but also carry the greatest risk. Fixed income investments (ex. bonds and bond funds) are generally less risky than stocks, but do not tend to provide as much investment return potential. Cash equivalents, such as money market funds, are generally the least risky asset class, but also provide the least opportunity for investment returns.

Investors with asset allocations weighted toward riskier investments are said to have a more aggressive asset allocation strategy. Conversely, investors with asset allocations weighted toward less risky investments are said to have a more conservative asset allocation strategy. Investors with a relatively even split of higher risk and lower risk asset allocations are said to have a balanced asset allocation strategy. As an example, below is one investor's asset allocation strategy.

Asset Class

Years to Retirement

40+

40 to 20

20 to 10

10 to 5

5 to 0

Equity Investments (Stocks and Real Estate)

100%

80%

60%

40%

20%

Fixed Income Investments (Bonds)

0%

20%

35%

50%

65%

Cash Equivalents (Money Market)

0%

0%

5%

10%

15%

Total

100%

100%

100%

100%

100%

Notice the asset allocation change from an aggressive asset allocation strategy to a conservative asset allocation strategy as the investor approaches retirement. Generally, investors closer to retirement should take less risk with their asset allocation strategy because they have less time to recoup potential investment losses. Likewise, investors further from retirement can assume more risk for potentially greater returns.

Knowing your retirement horizon is important before developing your personal asset allocation strategy. In addition, you should always consider investment objectives, risks, charges, and expenses before investing. If you would like to learn more or review your specific situation, our IRA Consultants are happy to assist.

The Most Important Financial Planning Question You Need to Answer

How much should you save toward retirement? Conventional wisdom tells us we should invest as much as possible for retirement in a well-diversified portfolio, and time will take care of the rest. Although this approach is simple, it does not answer a basic question: how much do I need to save, based on my unique situation? We can help you answer this question.

1) How old are you? / When do you intend to retire?

Generally, younger people who start saving early are in better positions than those who wait. Some studies have shown that the recommended savings rate for individuals who start to save at age 25 doubles if they wait until age 45, and triples if they wait until age 55 to start saving. While most people plan to retire in their 60s, some wish to work later in life, and others wish to retire earlier.

2) What percent of your pre-retirement income will you need in retirement?

In the financial planning world, this metric is known as your income replacement ratio. For most people, expenses decrease in retirement. In fact, studies show that health care related expenses are the only category of expense that will increase in retirement. In view of this, many financial planners recommend an income replacement ratio of 80%. Social security will cover some of this, but personal savings, other sources of income, and retirement accounts will need to cover the rest.

3) How much do you expect to earn from your investments?

Although there is never a guarantee in the financial markets, we do know that over time, stocks tend to outperform bonds and bonds tend to outperform cash. For long-term investors who invest primarily in stocks or stock mutual funds, planning for a 7% annual investment return is generally reasonable. Just remember, financial markets can be volatile over shot-term periods, so sticking to a long-term plan, even when you might be fearful is critical. However, always consult with professionals if you need specific advice.

4) How much have you already saved towards retirement?

If you have already started to save, you are in a far better position than those who have not.

5) How long do you need your retirement savings to last?

Actual life expectancy is unknown and planning for it is challenging. When attempting to plan for this, some people look at their family histories, lifestyle choices, current health situation, expected future health care advances, etc. All of these are sensible and appropriate. Generally, planning for a retirement of 20 years to 30 years is reasonable for most people.

Once we have answered the above questions, we can determine an appropriate savings rate. The below tables provide targeted retirement savings rates, based on a study published in the Journal of Financial Planning in April 2007.

Target Savings Rate by Age and Income

Income

25

30

35

40

45

50

55

60

20,000

5.8%

7.0%

8.6%

10.2%

12.4%

15.0%

18.6%

23.8%

40,000

8.2%

10.0%

12.2%

14.8%

18.0%

22.0%

27.2%

34.4%

60,000

10.0%

11.8%

14.6%

17.6%

21.4%

26.2%

32.6%

41.2%

80,000

11.2%

13.6%

16.4%

19.8%

24.0%

29.8%

36.6%

46.8%

100,000

   

17.6%

21.4%

26.2%

32.2%

40.2%

51.4%

120,000

       

28.2%

35.0%

43.6%

55.4%

 

Subtract from Target Savings Rate for each $10,000 Already Saved

20,000

1.60%

1.65%

1.75%

1.67%

1.76%

1.87%

2.11%

2.39%

40,000

0.78%

0.79%

0.86%

0.86%

0.90%

0.97%

1.04%

1.23%

60,000

0.55%

0.54%

0.55%

0.57%

0.59%

0.64%

0.71%

0.81%

80,000

0.40%

0.42%

0.43%

0.42%

0.45%

0.48%

0.53%

0.61%

100,000

   

0.34%

0.35%

0.37%

0.39%

0.43%

0.50%

120,000

       

0.31%

0.33%

0.36%

0.41%

For example, suppose a 40-year old earns $60,000 in annual income. Based on the first table, this individual has a suggested savings rate of 17.6%. Put another way, the 40-year old would need to save $10,560 per year towards retirement.

Now suppose the same 40-year old has already saved $50,000 towards retirement. From the second table, we reduce the savings rate by 0.57% for each $10,000 already saved. In this situation, the recommended savings rate is 14.75% = 17.6% - (5 x 0.57%). Here, the 40-year old would need to save $8,850 per year towards retirement. Obviously, starting to save for retirement early can be tremendously helpful.

The above tables are not without their limitations. They were built around single individuals with an 80% income replacement ratio, retiring at age 65 with full social security benefits. Although this may not be entirely consistent with your situation, the tables can serve as a useful starting point and guide. If you would like to learn more or review your specific situation, our IRA Consultants are happy to help.

Want Retirement Planning Advice? Don’t Ask Your Broker

In April 2016, the U.S. Department of Labor (DOL) issued final regulations about investment advice and fiduciary duties in workplace retirement plans. Although well-intentioned, the regulation has the unintended consequence of restricting or eliminating personalized retirement advice for millions of Americans, and you may be one of them.

So, what happened? Generally, under the DOL's regulation, any individual who receives compensation for making individualized investment recommendations to employers, participants of workplace retirement plans, or IRA owners for consideration in making investment decisions is a fiduciary.

So, what’s a fiduciary? Investment Advisers, who are regulated by the U.S. Securities and Exchange Commission (SEC), and many state financial regulatory agencies, are fiduciaries to their clients, and must act exclusively in their client’s best interests. This approach is known as a, “best interest standard of care.” Moreover, under federal laws which govern workplace retirement plans, fiduciaries must act exclusively in the best interests of plan participants and their beneficiaries.

This sounds pretty good, right? Often it is very good, but hundreds of thousands of financial professionals across the United States cannot engage with their clients as fiduciaries. Why? The vast majority of financial professionals in the United States are regulated by the Financial Industry National Regulatory Authority (FINRA), which adopts a, “suitability standard of care,” rather than a, “best interest standard of care.” In fact, most brokers with large well-established financial institutions cannot provide fiduciary advice to clients -- securities licensing, compliance rules, and/or regulations preclude it.

So, which standard of care is better, the SEC’s or FINARA’s? One standard is not necessarily better than the other -- it all depends on the unique objectives of the client, but the DOL has certainly made its opinion known.

If nothing else, the DOL’s fiduciary investment advice regulation exempts certain forms of general investment education and financial wellness materials, so participants will not be entirely left to fend for themselves. But, who wants general investment education? Sadly, it seems the quality, relevance, and personalization of investment advice available to you within workplace retirement plans will depend on who your employer or its plan administrative committee has hired. Many of those chartered with responsibilities for making those hiring decisions may not even know you.

If you do not want others to determine your financial future and the advice available to you, consider rolling over any workplace retirement plans of former employers. Under a rollover IRA, at least you have control over choosing your service provider and financial advisers, rather than leaving those decisions in the hands of others, who may be complete strangers.

5 Financial Mistakes to Avoid in Your New Job

Starting a new job can be exciting and full of opportunities. If you have recently started a new career, congratulations and best of luck. However, before you rush off to lunch or happy hour with your new co-workers, you should first work to avoid these common financial mistakes made by new employees.

  1. Forgetting to rollover your former employer’s workplace retirement plan account. When employees terminate employment, they earn the right to rollover their workplace retirement accounts. In the excitement to start something new, people often forget about retirement accounts with former employers. Why should you care? Employers maintain benefit plans for their current workforce, so many employers will charge additional fees to accounts of former employees for continuing to administer retirement benefits. Such fees are perfectly legal, provided the fee is reasonable and the services necessary. By rolling over your workplace retirement account to an IRA, you can avoid such potential fees, preserve your account’s tax-deferred status, engage investment advisers for personalized advice, and generally access a wider range of investment options.
  2. Failing to select appropriate withholding allowances. If someone unknown wanted to borrow hundreds or thousands of dollars from you at zero percent interest, would you let them? We didn’t think so. Unfortunately, workers do this when they set their tax withholding allowances too low. If you receive a federal tax refund from the IRS, know that the IRS is simply giving you back your own money, without interest. What can you do? Form W-4 tells your new employer how much money to withhold from your pay for federal income taxes. It is best to give the IRS what you expect to owe in taxes, and not a penny more. There are several online calculators that can help you determine an appropriate federal tax withholding amount.
  3. Delaying enrollment in your new employer’s workplace retirement plan. Most employers require employees to complete enrollment forms for workplace retirement plans. Why participate? Contributing to workplace retirement plans is convenient, carries meaningful tax benefits, and makes you eligible for potential employer matching contributions. If your employer offers a match and you do not contribute, you get nothing. Before you read any further, or get another cup of coffee, go directly to your human resources department and request a retirement plan enrollment form. Complete it now. If you have not satisfied your plan’s eligibility requirements, ask your employer to keep your completed enrollment form on file until you do.
  4. Contributing inadequately toward your retirement savings. Participating in a workplace retirement plan is the first step. Contributing adequately, is the single most important thing you can do for yourself. How much should you save? We recommend contributing 15% of compensation, starting from the moment you enter the workforce. As an example, if your employer matches 3%, then you may want to contribute 12% of your pay. If you are mid-career and have not started saving, then you should contribute more. Can’t afford that much? Try contributing as much as possible, and then increase your contribution rate by 1% each year.
  5. Neglecting your retirement account’s asset allocation. Investments with greater growth opportunities generally carry greater risk of loss. The right asset allocation lessens your risk of loss when financial markets decline, but also provide opportunities for gain when financial markets grow. When choosing an asset allocation, consider your investment time horizon, and personal risk tolerance. There are several free online investment risk profile questionnaires that can help.

By avoiding these financial pitfalls, you can begin your new job with confidence and financial peace of mind. If you need help or have additional questions, we invite you to contact us.

Wall Street Does Not Want You to Know This About Mutual Funds

One of the mutual fund industry’s dirty little secrets is that mutual funds with identical names, identical fund managers, and identical investment objectives are not identical. This is a lesson in the murky world of mutual fund share classes.

Mutual funds can be sold in different share classes, where the principal difference among share classes are the fees and expense the fund will charge you. In fact, it is common for a mutual fund to have some share classes that cost 100% or more than other competitively priced share classes. Imagine buying a car at your local auto dealer and the sales agent tells you that two cars of identical make, model, condition, and options were priced at $20,000 and $40,000 respectively. What would be your reaction? Sadly, this is exactly what is happening in the mutual fund business. More on that in a minute, but first a little background on mutual funds.

Mutual funds are collective pools of money, managed by professional investment managers. The investment manager makes all investment decisions. In fact, the only decision investors make is which investment manager they hire or fire. Investors hire managers by purchasing mutual fund shares. Investors fire managers by redeeming their mutual fund shares. When a mutual fund is purchased, the investor’s money is transferred into the mutual fund pool. Once in the pool, investment managers are in control and decide what to buy or sell (stocks, bonds, commodities, etc.). When you fire an investment manager by redeeming your shares, the mutual fund company returns to you the proceeds.

Investment managers do not manage money for charity — they do so for a fee. This fee is known as the mutual fund expense ratio. The expense ratio is expressed as a percentage and reflects the mutual fund’s annual charge to investors. Mutual funds generally calculate their fees daily, so a fund with an expense ratio of 2.00% may charge (2.00% / 365) against an investor’s balance each day.

Now let’s consider the effect of different share classes by looking at a real world example — the PIMCO Total Return Fund. As of this writing, the PIMCO Total Return Fund is among the largest mutual funds in the world. In fact, you may own this mutual fund in your Individual Retirement Account or 401k plan. The PIMCO Total Return Fund is offered in a range of share classes:

  • Share Class A (PTTAX) – Expense Ratio: 0.85%, Minimum Initial Purchase: $1,000
  • Share Class C (PTTCX) – Expense Ratio: 1.60%, Minimum Initial Purchase: $1,000
  • Share Class D (PTTDX) – Expense Ratio: 0.75%, Minimum Initial Purchase: $1,000
  • Share Class P (PTTPX) – Expense Ratio: 0.56%, Minimum Initial Purchase: $1 Million
  • Share Class R (PTRRX) – Expense Ratio: 1.10%, Minimum Initial Purchase: None
  • Share Class Admin (PTRAX) – Expense Ratio: 0.71%, Minimum Initial Purchase: $1 Million
  • Share Class Instl (PTTRX) – Expense Ratio: 0.46%, Minimum Initial Purchase: $1 Million

The mutual fund objectives and the investment manager are identical, but the expenses vary significantly among the share classes. Another significant difference among the share classes is the minimum initial purchase. Mutual fund companies often reward large investors with more favorably priced share classes because they are purchasing in bulk. It is similar to Costco selling bulk products for less than you pay at convenience stores.

What investors do not always know is that a better priced share class may be available. The savings to investors can be significant, especially when considering that mutual funds are often purchased in retirement accounts with a buy-and-hold investment strategy. Investors should do their homework before purchasing mutual funds, lest they risk spending more than necessary. If you would like to learn more or review your specific situation, our IRA Consultants are happy to assist.