Retirement investing isn't an exact a science. Rather than worrying whether the rules need to be tweaked, just start saving.
What keeps you up at night?
As a money manager, I recently polled my clients on several questions, and that was one of them. Replies ranged from “my bladder” to worries about the Federal Reserve printing too much money.
The most common answer, though, was fear of outliving one’s savings.
For decades, people have confronted the issue of how much they need to retire. Today the topic hits with special force. People are living longer, and the financial crisis of 2007-2009 set millions of people back twenty squares on the economic game board of life.
Now, there’s much debate about whether traditional retirement planning advice needs to be tweaked.
The traditional advice on income, for instance, is that people in retirement need about 60% to 70% of their old annual income to keep roughly the same standard of living. Remember, when you retire, your taxes may be lower, your children may be grown, your commuting and clothing expenses may shrink, and you may move out of a big house into a smaller house or apartment.
If savings and investments were your sole source of income, you would need – again, by conventional wisdom – about 25 times that sum in hand when you start your retirement. That is based on the traditional assumption that you can safely withdraw 4% of your initial nest egg each year and still have it last at least 30 years, regardless of market conditions.
That means if you earned $100,000 a year at the peak of your career, you would need about $65,000 a year in retirement, and 25 times that amount is $1,625,000.
Of course, inflation may increase your costs as years pass. If inflation runs at a 3% clip, a loaf of bread that costs $2.50 today will cost $4.50 in 2034. At 5% inflation, the same loaf would cost you $6.62.
You can offset some of the effects of inflation by your savings and investments, post-retirement. My father retired at 77 but invested in the stock market, logging prices and trends on charts he kept by hand. When he died at 98, his net worth had increased 75% from the day he retired.
Social Security can help, too. Despite doomsayers’ screeds, I believe the Social Security system will be around in 30 years. But benefits may be a little less generous than they are today.
These days, I see a lot of articles by financial planners questioning the guideline that it’s prudent to withdraw 4% a year.
I’ve seen planners argue for anything from a 2.8% withdrawal rate to a 5% one.
Those arguing for a smaller withdrawal rate — which implies the need for a bigger nest egg — say it’s hard to earn 4% a year after taxes without wading into risky investments. Savings accounts are paying a paltry 1% to 2%, and that’s before taxes.
But I think that’s a short-term view. Savings rates probably won’t stay as paltry as they are – just as inflation didn’t stay sky-high, as it was in the early 1980s.
For the long run, I think the 4% rule provides a decent, if crude, approximation.
Let’s be realistic here. Accumulating a pre-retirement hoard of 25 times the expected annual need is an ambitious target to start with.
But it’s something to strive for.
Two new products let you invest in companies led by female executives. Whether this is a good idea depends on what you hope to achieve.
On Thursday, Barclays is launching a new index and exchange-traded note (WIL) that lets retail investors buy shares — at $50 a pop — of a basket of large U.S. companies led by women, including PepsiCoPEPSICO INC. PEP -1.06% , IBMINTERNATIONAL BUSINESS MACHINES CORP. IBM -1% , and XeroxXEROX CORP. XRX -0.45% . This should be exciting news for anyone disappointed by the lack of women in top corporate roles.
The new ETN is not the only tool of its kind: This past June, former Bank of America executive Sallie Krawcheck opened an index fund tracking global companies with female leadership — and online brokerage Motif Investing currently offers a custom portfolio of shares in women-led companies.
The big question is whether this type of socially-conscious investing is valuable — either to investors or to the goal of increasing female corporate leadership. Is it wise to let your conscience dictate how you manage your savings? And assuming you care about gender representation in the corporate world, is there any evidence that these investments will actually lead to more diversity?
Here’s what experts and research suggest:
Getting better-than-average returns shouldn’t be your motivation. Beyond the promise of effecting social change, the Barclays and Pax indexes are marketed with the suggestion that woman-led companies tend to do better than peers. It’s true that some evidence shows businesses can benefit from female leadership, with correlations between more women in top positions and higher returns on equity, lower volatility, and market-beating returns.
But correlation isn’t causation, and other research suggests that when businesses appoint female leadership, it may be a sign that crisis is brewing — the so-called “glass cliff.” Yet another study finds that limiting your investments to socially-responsible companies comes with costs.
Taken together, the pros and cons of conscience-based investing seem generally to cancel each other out. “Our research shows socially responsible investments do no better or worse than the broader stock market,” says Morningstar fund analyst Robert Goldsborough. “Over time the ups and downs tend to even out.”
As always, fees should be a consideration. Even if the underlying companies in a fund are good investments, high fees can eat away at your returns. Krawcheck’s Pax Ellevate Global Women’s fund charges 0.99% — far more than the 0.30% fee for the Vanguard Total World Stock Index (VTWSX). Investing only in U.S. companies, the new Barclays ETN is cheaper, with 0.45% in expenses, though the comparable Vanguard S&P 500 ETF (VOO) charges only 0.05% — a difference that can add up over time:
If supporting women is very important to you, you might consider investing in a broad, cheap index and using the money you saved on fees to invest directly in the best female-led companies — or you could simply donate to a non-profit supporting women’s causes.
If you still love this idea, that’s okay — just limit your exposure. There is an argument that supporting female leadership through investments could be more powerful than making a donation to a non-profit. The hope is that if enough investor cash flows to businesses led by women, “companies will take notice” and make more efforts to advance women in top positions, says Sue Meirs, Barclays COO for Equity and Funds Structured Markets Sales in the Americas. If investing in one of these indexes feels like the best way to support top-down gender diversity — and worth the cost — you could do worse than these industry-diversified offerings. “Investing as a social statement can be a fine thing,” says financial planner Sheryl Garrett, “though you don’t want to put all of your money toward a token investment.” Garrett suggests limiting your exposure to 10% of your overall portfolio.
You don't need pricey money managers to help you buy low and sell high.
With the 4th of July on the way, the editors here at Money.com asked me to think about what it takes to become an independent investor.
I’ll take “independent” to mean something that most people with a 401(k) or an individual retirement account can realistically do. I’m not talking about sitting at your desk all day trading your own portfolio of stocks. In fact, the way I think about independence, you’ll want to automate about 99% of the investment decisions in your portfolio — specifically, which individual stocks and bonds to hold. The independence that matters has nothing to do with security selection. It’s about cutting out costly middlemen, from advisers who help you select investments, to the managers who pick the securities inside the mutual funds you may hold.
The rewards to doing this are significant. A high-cost mutual fund may shave 1% or more off of your investments each year, which can easily add up to six figures in fees and foregone gains over a lifetime as an investor. Eliminating layers of management also means you are less exposed to the quirky risks someone else might take with your money.
You don’t need a lot of time or expertise to pick these middleman-free investments. You can build a portfolio that holds a diversified slice of stocks and bonds with just three index mutual funds, portfolios that mimic the composition of the overall market at very low cost. If stocks rise 8% in a year, you’ll earn 8% or very close to it. You very likely have index options in your 401(k) plan—if not, say something to your HR manager!—and index funds are easy to buy in an IRA.
Below is what that portfolio might look like. You can adjust the split depending on you appetite for risk, but the one below is a good starting point for many long-term investors saving for retirement. (The less you can stand to lose, the more you’d add to the bond fund.)
In contrast to typical funds, this portfolio will cost you less than 0.1% of assets per year, and will get with three easy decisions exposure to literally thousands of stocks. You can choose index funds from our Money 50 list of recommended funds.
It’s easy to say that anyone can do this, of course. But I think a lot of people lean on investment middlemen because they aren’t sure they know enough about investing to do it themselves, and even if they want to learn, they aren’t sure which knowledge really matters. There’s so much you could dive into: stock sectors, “P/E” ratios, the January effect, EPS growth, upside earnings surprises, etc., and etc.
So here’s the one thing I think you have to understand to be a competent, on-you-own investor: Where the return on your investments really comes from. And the answer is that, for stocks, it comes from two sources. You own businesses, and you are taking a risk to do so.
Beginners are often introduced to the market with the old saying, “buy low and sell high.” This isn’t wrong (doing it the other way sure won’t feel good), but it’s not at all helpful. It makes investing sound a like a game of wits against other investors — first you figure out when a stock is too low, and then sell it when somebody else is willing to buy it for more than its worth. That’s hard, and you have to learn a lot about companies, accounting and human psychology to even attempt it. The whole edifice of the middleman money management business is built on the fact that most people believe they can’t do this themselves, or don’t want to.
But to be a buy-and-hold index investor, you can throw out “buy low/sell high” and the game-playing thinking that tends to go with it. This isn’t about finding a greater fool to buy your stock further down the road. Owning stocks gives you a claim on the earnings of companies. As an owner, you make money over time either because you are being paid a dividend out of profits, or because profits are being reinvested in the business to make it more valuable. Index funds give you a share in the future profits of the America’s, or the world’s, public companies. It’s almost as simple as that. Almost.
The other, crucial part of the equation is that the earnings of companies are uncertain and so are the cash flows shareholders will get. Stock investors get no promises that a company will ever earn enough to produce a dividend. Investors typically bake that risk into the market price of stocks, so that they can hope to be compensated with a higher return than they’d get on bonds. Historically, stocks have earned about 4.5 percentage points per year above bonds. Stock investors have on average been paid for risk — but that doesn’t mean you’ll always get paid for risk. Case in point: The nearly 50% loss investors took on blue chip stocks in the wake of the financial crisis.
If you get that, you have the baseline knowledge you need to build a diversified portfolio and stick with it. The potential for loss is built into stock investing and you only make money if you are willing to live that. The rest is (usually expensive) fiddling around the edges.
A financial pro gives a young investor some advice on the smartest ways to gain exposure to the market.
Q: I am in my early 20s and am looking to expand my investment portfolio. I currently have a small 401(k) and an S&P 500 index fund. Should I keep building up my index fund or start diversifying into something with a higher return potential? — Caroline, California
A: Participating in a 401(k) and investing in an S&P 500 index fund are a good start in your early 20s, notes Jim Ludwick, president of MainStreet Financial Planning.
Index funds — which simply buy and hold all the stocks in a market index such as the S&P 500 — aren’t as flashy as actively managed portfolios, where stock pickers can choose only those shares that they think are promising. However, index funds are a simple and inexpensive way to gain exposure to the market.
And there are years, depending on the market, where they can produce some sizeable gains. For instance, in 2013, the Vanguard 500 index fund, which tracks the S&P 500 index, returned more than 32%. That’s around three times the long-term average annual gain for stocks.
However, index funds are only as diverse as the market they track. So a good way to expand at this point would be to invest in other index funds that go beyond the S&P 500 index of U.S. blue chip stocks. An index fund that tracks the Russell 2000 index, for example, would give you exposure to shares of faster-growing small U.S. companies which your existing portfolio lacks.
You can add a Russell 2000 index fund to your mix to complement the S&P 500 fund, which gives you exposure just to large domestic companies.
Or for simplicity, you could trade in your S&P 500 fund for a so-called total market index fund, which in a single portfolio gives exposure to both large and small U.S. firms. “Expanding into a whole market index,” Ludwick notes, “is a very effective way to do it.”
Ludwick further highlighted the importance of investing in overseas markets for those seeking to expand and diversify. He noted that the Vanguard FTSE All-World ex.-U.S. ETF (ticker: VEU), which tracks stock markets outside the U.S., would be a good, low-cost complement to your U.S. holdings.
When investing in index funds, it’s important to comparison shop among vendors — Vanguard, Fidelity, Charles Schwab, iShares, SPDR all offer index products — for fees. Keep in mind that the expenses you pay are deducted from the market returns the fund generates, so the less a fund charges in fees, the more of its returns you get to keep.
Beyond index funds, you could branch out into actively managed portfolios. Studies have shown that over the long run, the majority of actively managed funds trail the basic indexes. Ludwick says active management is effective only in niche markets. That’s where the “insight really pays off,” he says.
However, as with all funds, the lower you can keep the fees, the better off you’re likely to be in the long run.
Investment adviser William Bernstein says there's no point in taking unnecessary risks. When you near retirement, shift your portfolio to safe assets.
A former neurologist turned investment adviser turned writer, William Bernstein has won respect for his ability to distill complex topics into accessible ideas. After launching a journal at his website, EfficientFrontier.com, he began writing numerous books, including “The Four Pillars of Investing” and “If You Can: How Millennials Can Get Rich Slowly.” (“If You Can,” normally $0.99 on Kindle, is free to MONEY.com readers on June 16.) His latest, “Rational Expectations: Asset Allocation for Investing Adults,” is written for advanced investors. But Bernstein, who manages money from his office in Portland, Oregon, is happy to break down the basics.
Q. Retirement investors have traditionally aimed to build the biggest nest egg possible by age 65. You recommend a different approach: figuring out how much you’ll need to spend in retirement, then choosing investments that will deliver that income. Why is this strategy a better one than the famous rule of withdrawing 4% of your portfolio?
There’s really nothing wrong with the 4% rule. But given the lower expected portfolio returns ahead, starting out with a 3.5% withdrawal, or even 3.0%, might be more appropriate.
It also makes a big difference whether you start out withdrawing 4% of your nest egg and increasing that amount by inflation annually, or withdrawing 4% of whatever you’ve got in your portfolio each year. The 4%-of-current-portfolio-value strategy may mean lower income in some years. But it is a lot safer than automatically increasing the initial withdrawal amount with inflation.
I also think that it makes sense to divide your portfolio into two separate buckets. The first one should be designed to safely meet your living expenses, above and beyond your Social Security and pension checks. In the second portfolio you can take investing risk in stocks. This approach is certainly a more psychologically sound way of doing things. Investing is first and foremost a game of psychology and discipline. If you lose that game, you’re toast.
Q. What are the best investments for a safe portfolio?
There are two ways to do it: a TIPS (Treasury Inflation-Protected Securities) bond ladder or by buying an inflation-adjusted immediate annuity. Neither is perfect. You might outlive your TIPS ladder, and/or your insurer could go bankrupt. But they are among the most reliable sources of income right now.
One other income source to consider: Social Security. Unless both you and your spouse have a low life expectancy, the best version of an inflation-adjusted annuity out there is bought by spending down your nest egg before age 70 so you can defer Social Security until then. That way, you, or your spouse, will receive the maximum benefit.
Q. Fixed-income returns are hard to live on these days.
Yes, the yields on both TIPS and annuities are low. The good news is that those yields are the result of central bank policy, and that policy has caused the value of a balanced portfolio of stocks and bonds to grow larger than it would have in a normal economic cycle—so you have more money to buy those annuities and TIPS. That said, there’s nothing wrong with delaying those purchases for now and sticking with short-term bonds or intermediate bonds.
Q. How much do people need to save to ensure success?
Your target should be to save 25 years of residual living expenses, which is the amount that isn’t covered by Social Security and a pension, if you get one. Say you need $70,000 to live on, and your Social Security and pension amount to $30,000. You’ll have to come up with $40,000 to pay your remaining expenses. To produce that income, you’ll need a safe portfolio of $1 million, assuming a 4% withdrawal rate.
Q. Given today’s high market valuations, should older investors move money out of stocks now for safety? How about Millennial or Gen X investors?
Younger investors should hold the largest stock allocations, since they have time to recover from market downturns—and a bear market would give them the opportunity to buy at bargain prices. Millennials should try to save 15% of their income, as I recommend in my book, “If You Can.”
But if you’re in or near retirement, it all depends on how close you are to having the right-sized safe portfolio and how much stock you hold. If you don’t have enough in safe assets, then your stock allocation should be well below 50% of your portfolio. If you have more than that in stocks, bad market returns at the start of your retirement, combined with withdrawals, could wipe you out within a decade. If you have enough saved in safe assets, then everything else can be invested in stocks.
If you’re somewhere in between, it’s tricky. You need to make the transition between the aggressive portfolio of your early years and the conservative portfolio of your later years, when stocks are potentially toxic. You should start lightening up on stocks and building up your safe assets five to 10 years before retirement. And if you haven’t saved enough, think about working another couple of years—if you can.
In theory, the rational thing to do would be to just hold on to your stocks as they climb higher. But occasional rebalancing can protect you when the markets go bonkers.
You’ve probably heard these two very respectable pieces of investment advice before, and probably from the same experts:
1. Stick with index funds. Most stock fund managers don’t beat the market, especially after fees. So save the money and trouble and buy a cheap fund that passively tracks the S&P 500 or some other broad index.
2. Rebalance regularly. When the stock market goes up sharply, your stock portfolio will grow in value. That means you’ll end up having more than your intended allocation in equities. The reverse is true if stocks drop sharply. Getting back to your target resets your risk and, as a bonus, means you automatically buy stocks when they get cheap and sell when they get expensive.
What if I told you that believing in both indexing and rebalancing is logically flawed? That’s right: They are incompatible ideas.
The case for indexing is built in part on an idea called the Efficient Markets Hypothesis, which says that markets are extremely good at processing information and insights and then turning them into stocks prices. Maybe you think a stock is a great buy at today’s price, but there’s someone on the other side of the trade who has lots of good information who thinks its time to sell. With a world full of smart, informed investors facing off in the market, it’s unlikely that you’ll consistently be able to be on the right side of the trade.
And if you believe that about individual stocks, the same would seem to be true for markets as a whole. If stocks are rising, you are in effect second-guessing the market when you sell to rebalance.
Don’t just take my word for it. Nobel-prize winning economists Bill Sharpe says so. And Jack Bogle, the founder of index-fund pioneer Vanguard, usually prefers staying the course. And contrary to the idea that rebalancing is inherently conservative, rebalancing involves plowing money into assets that are falling. That’s great if the asset later bounces back. But it doesn’t have to. (In the admittedly unrealistic situation where a stock drops straight down, the perverse result is that you’d rebalance until you went broke.)
I find these arguments against rebalancing pretty convincing, and that’s why I don’t do it often. (Money’s Penelope Wang has an excellent take on all this here.)
But recently even Bogle has sounded flexible about the idea of stepping away from a hot market. One reason you might want to rebalance at least sometimes is that we don’t really have an Efficient Market. We have an Efficient Market With Bozos.
The market isn’t totally unpredictable, in other words. Some kinds of stocks, like cheap value stocks, seem to do better over long periods. High market prices as measured by gauges like the average price-earnings ratio do seem to predict low returns ahead. Low prices predict high returns. There are all kinds of possible reasons for these effects, but investment writer and adviser Bill Bernstein in a recent ETF.com interview attributes them to “bozos” in the market.
…dumb money piles into [the market], and that produces the inevitable popping of the bubble, and people say: “This is risky!” And they sell out, just at the wrong time.
Now, in practice, I’m uncomfortable (as I’m sure Bernstein is) with ever writing off the market as dumb — doing so basically requires believing that everyone is stupid except oneself. You can make that argument at almost any time, depending on your level of self-esteem.
The reason the Efficient Market With Bozos theory is helpful isn’t only about the other investors. It’s about you—and me. We all have a bozo inside us.
A rebalancing rule, even when observed only sporadically, can protect you from getting swept up in market enthusiasm. When stocks are booming and you’re feeling optimistic—or left out of the party because you weren’t more aggressive—rebalancing pulls you in the other direction. Even if you don’t actually do it, the thought that maybe you should rebalance and sell may be a brake on the urge to buy.
This may be more important to do when markets are rising. Although this may be bozo-ishly inconsistent and unempirical, I suspect that for most people rebalancing in serious bear markets is both too difficult and, in some cases, too dangerous. As 2008 showed, when markets are dropping hard, other risks—like the possibility that you’ll lose your job—may be rising. And while the math might say that buying stocks when they are cheap will boost your returns, in falling markets you may also be at risk of tapping out your portfolio if you stay too aggressive.
In other words, it’s better to defend yourself against the bozos out there than it is to try to take advantage of them.
A new group of funds that claim to outperform the broad market while taking less risk are worth exploring—if you're willing to look under the hood.
Ever since the dot-com crash more than a decade ago, Wall Street and the mutual fund industry have been on a relentless push to plug what they are now calling “smart” beta strategies. These funds promise reasonable returns with lower risk through a variety of techniques.
But pursuing a smart-beta strategy isn’t as simple as just buying a fund with that name and thinking it will outperform conventional index funds. There’s always a trade-off in costs, risk and return, so you need to dig much deeper to get beyond simplistic marketing pitches.
For example, let’s say you were seeking an alternative strategy to traditional S&P 500 index funds that weight the holdings in their portfolios by market valuation.
In such traditional “cap-weighted” S&P 500 funds, the top holdings would be Apple APPLE INC. AAPL -0.67% at about 3% of the portfolio, followed by ExxonMobil EXXONMOBIL CORPORATION XOM -0.5% at 2.6% and Microsoft MICROSOFT CORP. MSFT -0.52% at just under 2%. Every other stock in the portfolio would represent a slightly lower percentage of the total holdings.
The idea behind cap-weighting is that the biggest U.S. stocks by popularity ought to represent the largest portions of a broad-market portfolio. This is what economist John Maynard Keynes called a “beauty contest,” with investors bidding up the prices of the most glamorous stocks. The downside is that these companies may be overpriced and may not have as much room to grow as other, bargain-priced stocks.
One alternative in the smart beta fund category is a so-called equal-weighted stock index fund such as the Guggenheim S&P 500 Equal-weight ETF RYDEX ETF TR GUGGENHEM S&P500 EQUAL WEIG RSP -0.47% , which holds the same stocks as the S&P Index, only in equal proportions. This design somewhat side-steps the overpricing issue because it’s less exposed to beauty contestants, especially when they falter a bit.
To date, both the long- and short-term performance of the equal-weighted strategy has been better than cap-weighted index funds. The Guggenheim fund has beaten the S&P 500 index over the past three, five and 10 years. With an annualized return of 9.7% over the past decade through June 6, it’s topped the S&P index by more than two percentage points over that period. But it costs 0.40% in annual expenses, compared with 0.09% for the SPDR S&P 500 Index ETF.
Once you start to ignore the beauty pageant for stocks, is there an even “smarter beta” strategy?
What if you picked the best stocks based on a combination of value, sales, cash flow and dividends? You might find even more bargains in this pool of companies. They’d have strong fundamentals and might be more consistently profitable over time.
One leading “fundamentally weighted” portfolio, which also resides under the smart beta umbrella, is the PowerShares FTSE RAFI US 1000 ETF POWERSHARES EXCHAN FTSE RAFI US 1000 PORTFOLIO PRF -0.43% , which also has outperformed the S&P 500 by about two percentage points over the past five years with an annualized return of 20 percent through June 6. It costs 0.39% annually for management expenses.
The PowerShares fund owns some of the most-popular S&P Index stocks like Exxon Mobil, Chevron CHEVRON CORP. CVX 0% and AT&T AT&T INC. T -1.19% , only in much different proportions relative to the cap-weighted indexes. The RAFI approach focuses more on cash, dividends and finding undervalued companies, so it’s not necessarily looking for the most-popular stocks.
Although looking at the rear-view mirror for index-beating returns seems to make equal- and fundamental-weighted strategies appear promising long term, you also have to look at internal expenses to see which strategy might have the edge.
Turnover, or the percentage of the portfolio that’s bought and sold in a year, is worth gauging in both funds. Generally, the higher the turnover, the more costly the fund is to run. That eats into your total return. The PowerShares fund has the advantage here with an annual turnover of 13%, compared to 37% for the Guggenheim fund.
Over the long term, “fundamentally weighted smart beta strategies are likely to outperform the equal weighted approach,” note Engin Kose and Max Moroz with Research Affiliates, a financial research company based in Newport Beach, California, which largely developed the concept of fundamental weighting and is behind RAFI-named indexes.
But just considering costs doesn’t end the debate on equal- and fundamentally weighted funds. While they may be higher-performing than most U.S. stock index funds over time, they are not immune from downturns. Both lost more than the S&P 500 in 2008 and 2011.
While it may be difficult to predict how these funds will perform in a flat economy or a sell-off, they are worth considering to replace your core stock holdings, and may be the wisest choices among the smarter strategies.
A semi-annual examination of your holdings will make sure your investments are still on track. Before you kick back for the summer, review and adjust your portfolio for maximum performance.
Even if you’re feeling fine, you still visit the doctor now and then to make sure everything’s all right. Well, your portfolio deserves the same level of care. For instance, you may be pleased that the broad market is up again this year—continuing a bull run that has tripled your equity stake since 2009.
Yet investment success often brings with it a growing exposure to risk—perhaps too great to tolerate. See the chart below:
Book losses now to capture an important tax break.
You don’t want to be a short-term investor, but you also don’t want to look a tax gift horse in the mouth.
Chances are, you’re sitting on hefty gains after the recent bull run. Want to take some profits off the table by selling winning shares of stocks, funds, or ETFs, but are reluctant to do so for fear of triggering a big capital gains bill? Book some losses now and Uncle Sam will let you offset those gains.
Normally, investors “harvest losses” at the end of the year. However, “you need to plan ahead” in case some of those losses evaporate, says Ann Arbor planner Rob Oliver.
Where to start? Emerging-market equity portfolios have fallen over the past three years, while Chinese region funds have lost more than 8% of their value so far in 2014. Other fertile ground: stock funds that specialize in gold and other precious metal–related investments (down 24% annually over the past three years), and shares of fast-growing small companies (down 7% year to date).
Tip: Don’t upset your portfolio just to take advantage of this break. While the IRS’s wash-sales rule bars you from buying the same or a “substantially identical” investment within 30 days of a sale, there’s nothing stopping you from selling an individual stock or an actively managed portfolio and replacing it with an index fund that covers the same asset. “If you sell a housing stock at a loss, you could buy a housing industry ETF,” says Pittsburgh adviser Jim Holtzman.
The market has changed your portfolio, so change it back.
“This is the first time in years that rebalancing has become really necessary,” says John Rekenthaler, director of research at Morningstar.
That’s because of the wide gap in performance between stocks and bonds lately. While equities posted double-digit annualized gains since 2009, fixed-income investments have returned just 4.8% a year.
Even if you rebalanced as recently as two years ago, you’ll want to at least revisit your mix. Why? Say you started off with a portfolio that was 70% in equities and 30% in bonds in May 2012. Because stocks have soared 45% since then while fixed income has been mostly flat, your portfolio is now 77% stocks and just 23% bonds.
Tip: Review your portfolio semiannually, but make adjustments only if your mix is substantially off—five percentage points or more above or below target. Rebalancing reduces portfolio risk, but there are times when it can also cut into returns. Use this strategy only when your exposure to certain assets grows uncomfortably high.
Make sure your life hasn’t changed either.
Unless you hold the bulk of your assets in a target-date retirement fund—which automatically shifts your mix for you, growing gradually more conservative over time—you’ll have to tweak your approach every now and then simply to reflect changes in your life.
For instance, as a 40-year-old you might have been comfortable holding 80% in equities, but at 50 you’re playing with greater sums and less time, so you might want to cap it at 60% to 65%.
Tip: To show how your asset mix should shift as your circumstances change, check out the free asset allocation calculator at Bankrate.com’s retirement section. Also, when you execute these changes, start in your 401(k)s and IRAs, where you won’t trigger capital gains taxes by selling. Why generate a tax bill when you don’t have to?
Controversial Jeopardy champion Arthur Chu talks with MONEY about risk-taking, his long-term goals, and why he isn't in the market for a shiny convertible.
Earlier this year, Arthur Chu won a staggering 11 games on Jeopardy, nearly $300,000 in prize money, and the unofficial title of “Jeopardy Villain.”
Chu upset some gameshow purists with his counter-intuitive tactics. For instance, he relied on game theory to outmatch his opponents. Chu would often skip around from category to category and select the most valuable answers first. Fans who were used to contestants staying in one category, and starting with the least valuable answers, chafed at his approach. (Although Chu is hardly Jeopardy’s first unconventional player.)
A few months after his epic run, Chu had to figure out what to do with his winnings, and how to adjust to life with a lot more money in the bank.
The 30-year-old voice-over artist and actor lives in Broadview Heights, Ohio, and recently spoke with MONEY.
(The interview has been edited.)
Viewers seemed to view you as a risky player, but you’ve maintained that your strategy was risk-averse. How so?
For some reason, probably because Jeopardy consistently refers to its points as “dollars,” people don’t get the most fundamental rule of how Jeopardy works — the points you earn in the game are NOT dollars. They only turn into money if you win the game, if after Final Jeopardy you’re in first place. If you aren’t in first place, all your points disappear, your total is completely erased and you either get the 2nd-place $2,000 or 3rd-place $1,000 consolation prize and go home.
The expected value of winning the game versus losing is immense. Not one single dollar in your stack is worth anything if you lose. And yet people do irrational stuff all the time like make bets that ensure they’ll still “have something” if they lose the bet, even though if you lose the game “having something” and “having $0″ are completely equivalent — you get the same consolation prize either way.
So imagine if you had some bizarre contract where if your investment portfolio hit a certain value by a certain time limit, you get to keep the money. But if it’s below that value all the money is taken away. Do you see how this would be different from normal investing? How “low-risk” moves would actually be very high-risk moves — the “safer” your portfolio is, the higher the risk that you won’t hit your target and win the game, and all your money will vanish?
Speaking of risk, how do you view risk in your own portfolio?
When all I had was a small amount of savings I was invested conservatively to make sure that our total funds wouldn’t dip too low in case we needed them — specifically the Vanguard LifeStrategy Conservative Growth Fund (VSCGX).
Now that I have a much bigger stack I’m sitting on and the capacity to absorb more downside risk I have it all invested aggressively in Vanguard’s Target Date 2050 Retirement Fund (VFIFX.) I’m trying to keep everything as automated as possible so that managing money can be one less drain on my thoughts and energy among all the other stuff I have to do.
What’s your long-term investing strategy? Do you own actively managed funds?
I’ve yet to see a compelling, rational argument that says you come out ahead with active investing — at least not without a lot more research and a lot more savvy that I really want to put into it. (You have to be able, as a non-financial professional yourself, to identify the managers you trust to give you above-market returns — and not just above-market returns but returns that are enough above market to justify the cut they take. I’ve yet to see a reliable method for doing this.)
What goals will your winnings allow you to achieve?
It’s not really buying stuff that matters most to me — the single thing I value most that’s most irreplaceable is my time. A nine-to-five job, while it comes with a lot of perks and a lot of security, takes the lion’s share of the hours in the day away from me and puts them toward something I’d rather not be doing. To be able to live a life basically like the one I have now but to have that time freed up — that’s worth more than any car or any cruise.
What does all of this money buy you?
The main thing it buys is a feeling of peace. I have no intention of quitting my job in the near future but just knowing that you don’t need a job is profoundly freeing.
Knowing that I could buy almost anything I wanted if I really wanted to is profoundly freeing — and, paradoxically, having this knowledge means I no longer think about things I want but can’t have nearly as much. When the thing that you’d be trading off for the lust-inspiring luxury is tangible — when I know that I’d be trading, say, six months of not having to work for a shiny new convertible — it puts things in perspective and helps push away the need to lust over such things.