"Save" doesn’t have to be a four letter word
July 26, 2010
Many of you remember the dot-com craze in the late ’90s. Just about any company with a “.com” in their name could issue an IPO and cash out millions without the actual company ever making a single dollar. Today, some “experts” would argue that gold is where your money should be. Who knows? It might be. But, are we too early or too late? With gold at $1,200 an ounce, have we missed the party or is it going even higher? I wish I knew the answers to these questions, but unfortunately I don’t. One thing I do know is that you don’t get rich chasing last year’s returns. Historically, the investor who develops a plan and sticks to it eventually comes out ahead in the long run.
Most investment strategies aim at satisfying our needs for retirement. The success or failure of this plan dictates how and when we retire. Although we know that saving for retirement is a complex and delicate and sometimes stressful thought for most, we like to think of it in its simplest of terms and break it down into three factors: Save, budget, and diversify.
At some point in our lives we’ve heard from our parents, neighbors, or friends that we need to start saving for retirement as early as possible. “Earlier is better,” they say. Well, they couldn’t be more right. Saving is a relative game, meaning it’s doesn’t matter how much you make, it matters how much you save relative to your income. By saving as a percentage, it puts everyone on a level playing field. For example, the doctor who saves $25,000 a year seems to be saving a lot of money, but if I told you he makes $500,000 in income a year, you’d probably re-think your stance. Now, the schoolteacher who saves $5,000 a year and makes $45,000 a year is on track for a healthy retirement. Studies show that in a 35-year work period, you can reproduce your income during your retirement years by saving just 10 percent of your current annual income. Another concept to consider is the idea of compounding interest. This simply means earning interest on interest. For example, $10,000 growing at 7 percent annually would double every 10 years. So in 30 years this same $10,000 would be worth $80,000. Perhaps this is something to consider before taking that early retirement.
The word “save” can also be considered a four-letter curse word for many couples. In a study by Lifestyle Magazine, money issues were the No. 1 reason for divorce. “We need to save more” or “Stop spending so much” are common topics or arguments amongst many couple. Typically, each couple has a spender and a saver. Unfortunately, more often than not, the spender wins. The easiest way for couples to avoid these situations is to establish a habit of saving early in the relationship and to set up automatic investments or direct deposits that withdraw money automatically from your paychecks before you even see it. We need to save first rather than thinking “I will see what is left over at the end of the month for the savings account.” This allows for you to spend guilt-free and at the same time build your assets toward retirement.
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Another important factor to building towards a healthy retirement is to budget. Budgeting is one of the few tools that you have 100 percent control of. By budgeting, you call the shots. Only you can decide what items make the budget or not.
A good example we like to use is Starbucks. We can all agree that Starbucks is delicious and that we should treat ourselves occasionally. But somehow we’ve turned a blind eye to the fact that we are paying $3 for a cup of coffee. Now, if a couple goes to Starbucks every workday morning and buys two coffees; that would equal $6 a day, $30 a week or $120 a month. If you were to invest that same $120 each month into a college savings account earning 8 percent a year in interest, this would give you roughly $53,000 after 18 years. This is enough to pay for almost all public colleges and at least two years at most private colleges in the country. Thinking of it this way allows you to see how saving a little each day can add up to a lot of money down the road.
Now that you saved and have a strong budget in place, the next big question becomes, “Where do I put my money?” We’ve all heard of asset allocation and diversification. According to Investopedia, asset allocations is “an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. The three main asset classes equities, fixed-income, and cash have different levels of risk and return, so each will behave differently over time.”
Now that your assets are allocated, it’s essential to diversify the portfolio in order to minimize risk. Again, according to Investopedia, Diversification is “a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.”
Studies have shown that asset allocation accounts for more than 90 percent of a portfolio’s return. So what does this mean? This means that you don’t need to try and find the next Google or Microsoft in order to retire rich. What you need is the right mix of assets in your portfolio, to continue your automatic investments and let your friend, neighbor or co-worker chase the next “great” stock pick.
Obviously the recent markets have been somewhat of a roller coaster when looking at a shorter time frame. This can be somewhat unnerving for some investors and this is why we like to look at the long-term picture.
Historically, markets tend to normalize over time and the longer you’re invested the smoother that ride becomes. Lately, the equity markets seem to move in whole percentages one way or another every day. In volatile times like these it makes sense to sit down with your financial advisor and make sure your allocation is still right for you. Your asset allocation is not a static mix. The allocation should change as changes occur in your life. Income, children and age are just a few factors that help determine your correct allocation. For example, the closer you get to retirement the less exposed you might want to be to this volatility and you may want to take a more conservative approach.
At Prutzman Wealth Management, we like to think of your investment strategy as a three-legged stool. All three factors are equally important and should receive equal attention. Neglecting any of these factors could result in a shortfall of your income goals. In the end, if you stay invested for the long-term, continue to invest in all markets (up or down) and maintain a consistent financial plan, you should be well on your way to reaching your retirement goals.
Thomas G. Prutzman is the founder of Prutzman Wealth Management in Reno. Kyle McCann is a wealth advisor with the firm. Contact them at 996-5672 or through http://www.prutzmanwm.com.