Category Archives: Investing

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Dollar Cost Averaging Versus Lump Sum Investing

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iStock_000016717083SmallI spoke to a number of boomers recently who were contemplating investing in bank or credit union Certificates of Deposit (CDs) because they were not comfortable with market volatility. They were asking about Dollar Cost Averaging versus Lump Sum Investing so I thought it was time to revisit the concept.

Dollar Cost Averaging, or DCA, (let’s face it, in this business everything has to be alphabet soup) is a strategy where you systematically invest a fixed dollar amount at regular intervals i.e. monthly or quarterly. It works best as a long-term strategy since the idea is that by systematically investing you are buying more shares when the market is down and fewer shares when the market is up thereby reducing the average share price that you pay for the security.

DCA isn’t designed to protect you from a loss in a declining market (although it can as we will discuss later) and it doesn’t guarantee a gain but it does eliminate the stress of deciding when to invest so you do away with “market timing”. It’s a disciplined strategy so make sure you have a longer term goal and the resources to maintain the strategy through the highs and lows.

You may not realize it but if you are investing through a retirement IRA or 401k you are in effect using a DCA strategy since money is coming out of your check each pay period and automatically invested in your 401k or IRA. Here’s a graph showing how the average share price is lowered using a DCA strategy courtesy of Forefield, Inc.:

Often the question comes up, “which is better, DCA or Lump Sum investing?” The answer isn’t that simple. Lump Sum investing depends on the timing of the investment.

If you enjoy following the market and consider yourself an experienced investor then you may feel confident timing the buying and selling of your investments and you may be able to outperform a DCA strategy. As we know, the markets are not predictable and many investors fall prey to the “buy high and sell low” trap. As a result their losses may be more severe than the DCA investor who is buying smaller amounts when the market is at a high.

Since a DCA investor is buying more shares of a security as the price declines there is some downside protection in a declining market. As the market rebounds the DCA investor will “break even” faster than their Lump Sum investor because the DCA investor owns more shares at a lower average price than the Lump Sum investor who invested before the market started declining.

Which makes the most sense for you? Among other factors it depends on what you goal is and how long you have to invest. It also depends on your risk tolerance and comfort level with investing in the market. You can get more information of how to find your risk tolerance here.

Keep in mind that it’s not an all of nothing proposition. DCA might make sense for part of your portfolio while investing with a lump sum may be suitable for another part of your portfolio. In either event the key is to stay invested and avoid jumping in and out of the market.

021014_0250_ToCDorNotto2.jpgTime Out! How do you feel about Dollar Cost Averaging versus Lump Sum investing? You can leave a comment here.

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To CD or Not to CD?

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I have worked with bank and credit union investment programs for many years. For those of you unaware, many banks and credit unions provide investment and financial planning services to their customers and members through a network of financial advisors who provide these services through the branch networks.

Availing yourself of this service through your bank or credit union can be a convenient way to obtain good advice about your retirement income and investment needs. As with any financial advisor you will need to do your due diligence. Most banks and credit unions partner with a broker dealer in order to provide these investment services and they do a good job of screening out the “bad” advisors. Still, make sure it’s a good fit before signing on with any financial professional.

One of the consistencies that I have experienced in my time with bank and credit union programs is that most investors who take advantage of these “in-house” investment programs are relatively conservative investors. A good chunk of the prospective clients for these programs have their money on deposit with the bank or credit union in Certificates of Deposit (CD) accounts.

Many people put their money in CDs for one of two main reasons. One, they need the interest to supplement their income and two; they plan to leave the money to their heirs when they die. In both cases a majority of bank/credit union CD holders are highly risk averse. They are generally older, 60 years old plus, so they have experienced the good and bad of the markets during their lifetimes, mostly the bad, which is why many continue to keep their money in CDs. Their logic is, “even if I don’t make anything, I won’t lose anything.”

Of course this “don’t lose anything” logic isn’t entirely accurate. You can lose when it comes to putting all of you money in CDs. When you consider the average 5-year CD rate is paying around 2.0% and the current inflation rate is hovering around 1.5% they are just barely keeping ahead of inflation with their money in CDs. Is it enough? Well, that’s where you and your financial advisor need to do some forecasting to see if the income from your CDs will last your lifetime.

If you can only lock up you money in a CD for 2 years or less then you will be lucky to earn 1% in which case you will lose money as the ravages of inflation will erode your purchasing power over time and you will “go backwards” with your investment plan. This is an important investment principle that many people overlook in their haste to keep their money “safe”.

So what is a conservative investor to do? The answer isn’t that simple. Emotions control the investment decisions we make. Our risk tolerance is a product of our life experiences and in many cases those of our parents and grandparents. I believe developing an understanding of basic investment principles in key such as the “compounding effect” of money and the “risk-return relationship”. Beyond that I believe there is still a way for conservative investors to have principle protection and still enjoy a better-than-CD rate of return.

It doesn’t mean one has to or should abandon CDs altogether. Depending on your unique situation CDs may need to be a part of your overall asset allocation strategy. I recommend that you work with a financial advisor to first assess your risk tolerance and then figure out what the best asset allocation is for you based on your goals.

The investment product manufacturers continue to develop products that are suitable for conservative investors. CD Funding Group has developed a series of “Market Linked CDs”. These are FDIC insured products with typically long-term maturities, but they are tied to either a basket of Blue Chip stocks or an index like the S&P 500. While you are not guaranteed any particular return your principal is guaranteed like a regular CD.

The market-linked CDs have a pretty impressive track record. Most banks and credit union financial advisors offer these. They are not for everyone yet they merit a close look by conservative investors. In addition, there are fixed annuities and variable annuities. While annuities have taken “hits” in the press over the years they have proven themselves to be excellent retirement income planning tools. Again, they are not a universal solution.

As with any product you need to shop around. Yes, there are fees associated with annuities; again as with any product that you purchase you have to evaluate what the value is that you are getting for those fees. In some cases it might be principal protection or a guaranteed income. Don’t take the criticisms of so-called experts at face value. Be an educated investor!

CDs have their place in retirement income portfolios. Like any investment, when you put all of your money in one asset class you still have risk. In the case of CDs you won’t risk loss of principle but you run the risk of inflation eating away the purchasing power of your money and the risk that the yield on those CDs won’t provide you with the income you need or the legacy that you hooped to leave to your heirs.

Time Out! What is keeping you invested in CDs? You can share your thoughts here.

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Beware the Lump Sum Scare

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An interesting article in the Wall Street Journal last week, Retiring on Your Own Terms, caught my eye with its claim that we should save 22 times the annual income that we want to live on in retirement.

If you have been following my blog you know that I’m not a big fan of this “lump sum” approach to retirement income planning. I think it can be demoralizing and often stops people from planning for retirement. The premise of the article is that you need to guarantee that you won’t run out of money not just hope and plan. It’s hard to argue with that point. The author goes on to explain how he came up with the 22 times approach.

Assume you want to live on $100,000 a year in retirement. Then you will need to save $2.2 million (22 times $100,000). There’s that lump sum idea again. The author suggests treating the money you will save like your personal pension. As such how would you guarantee that your invested dollars never lost money? You would invest in low/no risk assets like Treasury inflation protected securities (TIPS), U.S. government bonds that are tied to inflation. So you would have protection from inflation but… potentially no investment upside.

So assuming and planning for no growth you would end up with $2 million that you could withdraw for 20 years at $100,000 per year. The other $200,000 that you save? The article’s author recommends that you buy a deferred annuity to cover you if you live past age 85.

It’s not a bad strategy…I like the fact that it takes a conservative, pension-like approach to funding your retirement. The problem is with the execution. Once again, it dangles this “carrot” out there that most boomers will not be able to achieve. In other words, you still have to save enough over the next 20 years to achieve the targeted lump sum. What if you can’t? You throw up your hands in frustration and go back to the, “I’ll work till I drop dead” approach to retirement planning.

What if you like this approach? How can you incorporate this strategy into your retirement income planning? Here are the steps I recommend:

  1. Start with the end in mind – Sit down with a CFP (Certified Financial Planner) and figure out how much you have saved right now. Using the example from the article, let’s say you want to retire on $100,000 per year and you have $100,000 saved and you are 45 years old and you want to retire in 20 years.
  2. Look at your expenses – We need to look at what you spend now and what lifestyle you want when you retire. Most people want the same or as close to the same lifestyle that they have pre-retirement. So we typically use 70-80% of your pre-retirement expenses in retirement as a starting point.
  3. Don’t forget Social Security – This can make a huge difference in your retirement income projections. It’s a guaranteed annuity with inflation protection. We need to figure out when the best time to start taking benefits will be. Don’t assume it’s at age 65.
  4. Find the gap – I use a terrific program called Retirement Analyzer. Once we account for your assets, expenses, Social Security and other potential sources of income we can determine when you will or won’t run out of money. We call this the Red Line analysis. The Red Line is when you will run out of money. We want to push it beyond age 100 just to be safe – make it disappear!
  5. Bridge the Gap – Depending on where/if your Red Line shows up, for example, at say age 75, then we need to come up with Plan B. We call these the Red Line Solutions. What are those? Here are some examples:
    1. Modify when you start taking Social Security
    2. Work longer
    3. Work part-time in retirement
    4. Reduce expenses in retirement
    5. Increase contributions to retirement accounts
    6. Sell an asset

I explain these Red Line Solutions in more detail here. Don’t feel defeated or helpless when you read about the Lump Sum approach to retirement income planning. While the logic may be sound, as in the article I referenced, it doesn’t mean you have to achieve that lump sum in order to enjoy a successful retirement. With thoughtful planning and by working with a professional you can have a rewarding retirement. It may involve Plan B and one or more of the Red Line Solutions but that’s ok. Don’t give up. We can do this!


Time Out! Which Red Line solution looks most appealing to you if it looks like you will run out of money in retirement? You can leave a comment here.

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4 Keys to Financing Your Retirement if You Plan to Work Longer Than Expected

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A recent survey by Charles Schwab found that 95% of baby boomers say they won’t be willing to spend less in retirement. According to the Schwab survey people are coming to the realization that they want to have a good lifestyle in retirement even if it means they have to save more and work longer. Some of the frugality of the post 2008 meltdown appears to be wearing off. Some other survey figures show that 47% of workers age 65 and over are prepared to work in retirement.

Against the backdrop of those survey results it makes sense to look at some ways that boomers can maximize their income when they plan to work longer than perhaps they originally planned.

  1. Take Advantage of Your Salary Benefits. As long as you are making a salary you can continue to contribute to a retirement plan i.e. 401(k) or IRA. It’s a good idea to max out your contributions if possible. That way your accounts can continue to grow and take advantage of time and compounding before you start drawing on them for income once you retire. On the debt side you can also start using your salary to pay down debt before retirement. This will help lower your expenses once you retire.
  2. Higher Social Security benefits. As a general rule waiting to take Social Security benefits makes sense. Applying for Social Security benefits at normal retirement age produces a 25% higher benefit than applying for early benefits at age 62. If you wait until age 70 you will more than double the benefit compared to taking benefits at age 62. Keep in mind that Social Security is based on your highest 35 years of earnings. So if you work longer at your peak earnings you can replace some of those zero earning years early in your working life. You can get more details on Social Security in my FREE Guide to Social Security.
  3. Higher pension benefits. If you are fortunate to have a pension then your ongoing employment will likely boost your retirement payout since most pension payout formulas account for earnings and years of service. If your company has a 401(k) with a match you can continue to earn that match the longer you work. Again, put time and the compounding effect to work for you.
  4. Save on health insurance premiums. Always a big concern. Prior to Obamacare delaying retirement to ensure continued company-paid health care was an important consideration. Even with Obamacare affording pre-65 healthcare coverage can still be a concern. The chances are your company-provided plan is less expensive than an Obamacare plan.

Not everyone will be able to work longer to help finance retirement. The number one reason people are forced to retire early is health issues. Still, many boomers will decide to work in retirement by choice as well as by necessity. In either case it makes sense to take advantage of the benefits of earning a salary pre and post retirement. Plan well. Live better and enjoy retirement on your terms by taking advantage of the time you have now to finance it.


Time Out! How do you feel about working longer to finance your retirement? You can leave a comment here.

 

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5 Ways to Build Retirement Planning Momentum

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A recent study by Northwestern Mutual Insurance Company revealed some interesting reasons why people procrastinate when it comes to planning for their retirement. Among the findings:

– 24% of those surveyed stated they don’t have enough time

– 21% said they don’t have enough interest

– 20% find the whole process confusing

– 19% said they don’t know where to find help

Here are 5 ways that you can overcome these roadblocks and start some momentum toward your retirement goals:

  1. Take baby steps. Carve out 20 minutes a week to do something that will move you toward your retirement goals. The best place to start is with the “big picture” which leads to:
  2. Take a mental snapshot of what retirement looks like to you. Forget the TV advertisements or what your friends and coworkers talk about. You have to “move in” to your retirement dream so make sure that you like what you “see”. Start a retirement notebook. Include photos, magazine articles, and your own notes. Make this notebook your retirement “playbook”. This should help you develop an “interest” in your retirement by making it personal.
  3. Put a budget together. No, it’s not easy but use one of those weekly 20 minute sessions to start writing down what your income is and what you spend each month. This is a key step because before you can gain momentum with your savings and investing you need to know what you have to work with. You can use my Budget Tracker tool to help you with this step.
  4. Put a team together. I believe people find the process confusing because they think they have to do it alone or that they have to have “a lot of money” in order to get help. That’s why I am here to help you along with other CFP® professionals out there. You can also find a CFP® in you areas here.
  5. Start small. If you feel like you are behind in saving for retirement you are in good company. The average 401(k) balance for Baby Boomers is around $77,000. That’s hardly enough to last 20-30 years in retirement. So, we have two choices. We can throw up our hands and say, “Well I guess I will have to work until I drop dead.” Or we can put a stake in the ground and say, “I can’t relive the past so today I am beginning the momentum to carry me through “my retirement.”

Even a few dollars can have a dramatic impact on you retirement savings. Take a look at the power of time and compounding here. You may also find the SaveDaily platform a great place to start and/or increase your savings.

By just getting started you will jump to the other half of Americans who have some semblance of a “plan” for their retirement. Start small. Invest a few minutes a week to pick up your retirement “playbook” and take small steps toward your retirement goals.

Do this and before you know it you will have a clear picture of what retirement looks like for you and you will have at least an informal plan. Build retirement momentum and you find yourself less stressed out about what should be the time of your life.

Time Out! Which of these steps seems the most difficult for you? You can leave a comment here.