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.