ETF’s vs. index funds: fight!

Though the financial media buzz has faded somewhat in recent years, ETF’s (exchange-traded funds) exploded in popularity in the mid-2000’s as an alternative to index funds. What are they, and should you invest in them?

An exchange-traded fund is exactly what it says: a fund (mix of securities) that sells on a stock exchange. A regular mutual fund has its price re-computed at the end of the day by looking at the value of all of the securities that are in it; shares of an ETF, on the other hand, are actually bought and sold themselves. This seemingly small change can make all the difference in the world:

  • ETF’s often (but not always) have lower expense ratios than their corresponding indexes. Why? Because a mutual fund firm has to deal with a lot of paperwork when mutual funds are bought and sold, because they are the ones that have to process it. Not so with an ETF; since they’re sold on a stock exchange, the brokers do all the work there. (The ETF has some work to do — I’ve sidestepped the whole issue of how the price is maintained — but it’s comparatively small peanuts.) This alone can be a good reason to invest in ETF’s, as expense ratios are just about the only way to differentiate between funds that follow the same index, but that advantage comes with several less-obvious disadvantages:
  • ETF’s often (but not always) have commissions. Since you have to buy and sell ETF’s through a brokerage like Schwab or Fidelity, they’ll often charge you a commission to make the trade. If you’re putting a part of your paycheck into an IRA every month, this can quickly eat up any gains you may have gotten over an index fund (and then some!). However, many of the ETF’s most investors are interested in are offered commission-free by the broker; you just have to be careful what you buy. (Of course, mutual funds often have commissions, too.)
  • ETF’s are very difficult to auto-invest. As of this writing, the only popular brokerage I know of that allows you to automatically invest in an ETF is ING’s Sharebuilder, which, while cheap at $4 per automatic investment, is not commission-free. The others only allow automatic investment for mutual funds. Of course, if your ETF has a commission, you probably won’t be automatically investing monthly anyway; likely, you’ll save up in a money market account every month, then invest in ETF’s once every three or four months, so you’re only charged the commission three or four times a year. Either way, it’s not as easy as mutual funds.
  • ETF shares are generally more cumbersome to trade. With mutual funds, you just tell your mutual fund company how many dollars of your funds you want to buy, sell, or exchange (in the case of rebalancing), and the firm takes care of it all at the end of the day, no muss, no fuss. With ETF’s, if you’re rebalancing, you have to sell the shares from the too-high ETF, wait for everthing to clear, then buy the shares from the too-low ETF. And in the meantime, because you can only buy whole shares, you’ve got money piling up in your money market account, leftover from each trade. On the whole, annoying.
  • ETF’s have a bid/ask spread. Because they’re traded on an exchange, there’s a small amount of “friction” involved in buying or selling an ETF, in the form of a bid/ask spread. The more you trade, the more the spread will eat into your returns. Mutual funds do not have this problem.

So, are all the disadvantages worth the lower expense? They can be; however, it’s worth it to sit down and plot out how much you would save in dollars per year if you moved from an index fund to an ETF, and make your decision based on that.

(One note: if you use Vanguard (and I highly recommend you do), there’s virtually no reason to use an ETF. Why? Because they recently lowered the minimum for purchasing Admiral Shares of many of their funds to $10,000, making them very accessible, and in just about every instance, the expense ratio for Admiral Shares is exactly that of the corresponding ETF!)

Got a preference? Tell us about it in the comments!


your own worst enemy

There are two stories that I am tired of hearing.

One is a story of greed. I heard it a lot around the turn of the century, and again just before the 2008 crash. It took many forms: day-trading with a 401(k); dumping Oracle stock for that of a smaller company because the database giant was “only” scheduled to double; after some clever analysis, placing a disproportional bet on muni bonds. In every case, the portfolio in question became dangerously out of balance, and when the inevitable crash came, it lost far more than its share. In the cases where its owner was approaching retirement, the impact was disastrous.

The other is a story of fear, and I’m hearing it a lot now.  Retirees whose entire portfolio is in cash, and pre-retirees who are considering not bothering with their 401(k) anymore — because it seems that no matter how much they put in, the balance stays the same or goes down.

Of course, neither of these stories has a happy ending — they’re the source of the Behavior Gap that Carl Richards is so fond of talking about. It’s easy to blame them on fear or greed, but that’s really only part of the story. A more sinister villain is also at play here: recency bias, the well-known tendency of humans to believe — irrationally! — that things are going to stay the way they are, whether good or bad. In 1999, everyone knew that tech stocks were going to continue to go through the roof; in 2006, everyone knew that real estate was a sure bet; in 2008, everyone knew that the stock market was going to plummet forever. (You might ask yourself: what does everyone know now?)

Recency bias is a powerful enemy, though. It masks itself as rational behavior — why keep my money in bonds when stocks are going to continue to outperform? Why keep my money in stocks when they’re going to continue to remain volatile? And in our effort to stay informed, we expose ourselves to an amplification effect from the financial media (whose job, recall, is not to give us unbiased information, but to sell copy) that barrages us with provocative headlines like “Are Stocks Dead?” and “Is This The New Normal?” It’s enough to make even the most rational investor bail out (or jump in, as the case may be).

So what’s a poor human to do? Well, you know my answer: systems. In the case of investing and saving for retirement, there are some handy weapons in your arsenal for dealing with your own worst enemy (yourself); stay tuned for next week’s post, when I’ll introduce you to some of them!

the ins and outs of espp’s, part 3: so now what?

So I gave you a summary of what ESPP’s were all about, then went into detail on the intricacies of ESPP’s and taxes. Now: what exactly are we to do with all this information? Should you participate in your company’s program, or not? And if so, how long should you hold on? Well, everyone’s situation is different, but for most people, I would say this: participate in your company’s plan as much as you are able, and sell as soon as you can. I’ll break down the reasons why, so you can see whether this applies to you in particular.

Participate, because it’s free money. The discounted price at which you get to buy the stock is, if you sell immediately, almost always guaranteed free money. (Among the exceptions are companies with extremely volatile or rarely-traded stock.) If you don’t participate, you are, as they say, leaving money on the table. Obviously you don’t want to go into debt over it, but if you can swing it, do it!

Sell immediately, because to do otherwise is to greatly increase your risk. Holding onto these shares is, in most cases, a highly risky proposition. Yes, holding onto them for long enough to make a qualified disposition may give you some tax advantage, but is it really worth dealing with the ups and downs of your company’s stock?

Moreover, if you think of an “investment” as a “source of future income”, you’re already highly invested in the company you work for. For diversification’s sake, do you really want to put even more eggs in that basket?

“OK,” you may say, “but what do I do, then, with this sudden influx of cash?” Well, your first instinct may be to splurge — and if so, that’s OK. Set aside some amount you feel comfortable with — say, 5 or 10% — and go for it. Consider giving some of it away, as well; chances are, if you have access to an ESPP, you’re in a position to help other folks out. Set the rest aside — either for basic financial goals or long-term ones, like retirement or your children’s education.

Of course, I know several engineers who quite simply and literally have more money than they know what to do with. You know who you are — and that’s perfectly OK. I may go into more detail on recommendations in a future post, but for now (assuming you’re already maxing out what options you have in the way of tax-advantaged accounts), I’ll just recommend parking the money in a well-diversified balanced stock-bond fund, such as the T. Rowe Price Balanced Fund, the Vanguard LifeStrategy Moderate Growth Fund, or the Fidelity Balanced Fund. Any of those will give you a nice, simple, inexpensive compromise between returns and stability until you decide you want to pull that “mad money” out.

Now that I’ve said that: what do you currently do with your ESPP, if you have one? Has this post given you any new ideas?

the ins and outs of espp’s, part 1

Employee Stock Purchase Plans are, like much in the stock-related world, a double-edged sword. Depending on how you swing them, they can either be a handy supplement to your paycheck or just another source of complexity and, in the worst case, a way to flush income down the drain. As many of my fellow geeks have access to them — though not as many as a decade ago — I’d like to take some time to talk about them. Even if you’re already familiar with ESPP’s, it’s a good idea to know what’s out there — not every company’s plan works the same as yours, and it’s handy to know what the possibilities are when you’re job-hunting!

The idea behind the ESPP is relatively simple: as part of the benefits your employer is showering upon you — like manna from the heavens — you are given the opportunity to buy their stock at a discount. Nothing in the world of employer benefits is ever that simple, of course, so I’ll walk through the caveats.

The money for purchasing this stock is withheld from your paycheck. In this way, ESPP’s are much like 401(k)’s: you allocate a certain amount of your paycheck to be withheld, and that amount never graces your bank accounts. Also, there are heavy restrictions on when you can change that allocation; generally you can jump out if you like, but you can’t jump back in until the beginning of the next ESPP period.

The stock is often (not always) purchased in one chunk, at the end of the ESPP period. In this case, rather than buying stock each time you get a paycheck, it’s all purchased at the end of an ESPP period (generally 3 or 6 months). You can expect to see fun little jumps in your employer’s stock price on that day, as some/many/most employees (depending on the company) turn around and sell their newfound shares (and speculators buy or sell in response to this).

There is a cap on how much you can purchase. The cap can be either a maximum percentage of your paycheck, or a maximum number of shares bought, or both.

The discount varies greatly with the employer. Most common is a range from 5%-15%; alternately, the company may “match” your contributions to the ESPP up to a certain percentage of your income. Also, the discounted price is not always the fair market value on the day the stock is bought; it could be the lower of that price and the price at the beginning of the period, or even the price at the beginning of a window of periods! For example: say your employer’s stock price was $10 when you joined a year ago, $20 at the beginning of the last period, and $30 today, the end of the latest ESPP period. Depending on your employer, the buy price could be 5%/10%/15% of $30, $20, or even $10!

Depending on the company, it may not be a guaranteed win. In most cases, if you sell immediately you’ll lock in your profit and get a nice bonus. However, if you work for a company with a highly-volatile stock price (e.g. a “microcap”), you can lose your discount (and more!) by the time you sell your stock.

The taxes on ESPP’s are…interesting. So interesting, in fact, that I’ll be devoting my entire next post to them!

See you then! In the meantime, tell us about your ESPP — has it done well by you? And does it fall into one of the above descriptions, or is it a variant that wasn’t covered?

some perspective on investment choices

99% of the time, when people talk about investing, they talk about investment choices. What are you investing in? What do you buy or sell, and when? Have you found the next Apple or Google? It’s fun to talk about — a co-worker of mine recently told me about how he invested in copper mining companies in anticipation of the Beijing Olympics — but I’d like to offer some numbers, and some perspective.

To keep things simple, let’s say you’ve got a retirement investment portfolio that returns 10%, year-on-year. Of course, no portfolio is actually going to do that — anything returning 10% is going to carry a lot of risk, and thus, will vary quite a bit from year to year — but that’s okay for what we’re looking at. For this imaginary portfolio, if you invested $200 every month — $2400 a year — after 30 years, you’d have $452,098. (Edit: of course, the assumption that you’re investing a constant amount for thirty years, rather than increasing your investment as your income increases, is also unrealistic (not to mention unwise!). But again, this is okay for our purposes.)

Not too shabby, but most people I know would want more in their retirement accounts before they’d feel comfortable calling in rich. The first thing people generally think about is how to increase that return rate. Maybe you have an awesome hedge fund, or a killer advisor, or the perfect asset allocation, or you consistently pick more good stocks than bad every year for thirty years. If they’re really, really good, maybe you’ll get an extra 2%, net of fees (whether they’re charged by the hedge fund, your advisor, or your brokerage for all those trades). Now, that may not sound like much, but don’t be fooled — that extra 2% will get you $689,993, almost $250,000 more than (over 1.5x) what you would have gotten otherwise. (For the rest of this illustration, though, let’s assume you didn’t get lucky and are earning 10%.)

But wait — we forgot about taxes. If this is after-tax money in a Roth IRA, then our illustration still stands. But what if it’s in a normal brokerage account? Well, at current capital gains rates, 15% of your returns would go to Uncle Sam every year, bringing our nominal 10% rate down to 8.5%. (Edit: to be fair, this is an unrealistically worst-case scenario. By letting your money compound for as long as possible before selling, you can reduce this hit significantly.) Suddenly, your ending portfolio goes down to $330,141; you’ve lost over $120,000, almost a quarter of that bundle.

OK, so we definitely want to take taxes into careful consideration. But what if we go a step further and boost our savings rate — maybe we invest in a 401(k) with a company match, or simply max out our allowable IRA contributions? Well, if we upped that $200 to $400/month, we’d end up with $904,195. (Yes, that is exactly twice the $200/month number — the distributive property in action.)

Alright, that’s almost a million dollars, and it’s all in tax-advantaged accounts. But there’s one more thing we can do — what if instead of increasing our savings, we had just started investing earlier. Thirty years represents a 35-year-old waking up one day and saying, “hey, if I want to retire at 65, I better get a move on” — what if we started saving $100/month right out of college? After 44 years, you would have one million, eight hundred ninety-five thousand, five hundred and three dollars.

I can’t make the point any clearer: start saving for retirement now. Even if you can only go with $50 or even $25 a month — start with the basic advice here, and refine your investing strategy as you go. Yes, investment choices, taxes, and putting a lot away are all important, but they all pale in comparison to starting as soon as you can (and gradually increasing your contributions over time).

Photo by Journey Photographic.

the academic and the businessman: two views on investing

In case there was every any doubt: investing is not an exact science. After all, it depends quite literally on predicting the future, and as the Galbraith quote goes: “The only function of economic forecasting is to make astrology look respectable.” So it’s no surprise that there are as many ideas on investing as there are people, which can make for a lot of confusion. Let’s take a look at two of them: what I’ll call the Academic and the Businessman.

The Academic looks at investing in a very abstract sense. His main goal is to balance risk versus reward, using his knowledge of Modern Portfolio Theory. He knows that the two often go hand-in-hand, but that diversification is key, which will greatly reduce the risk while still keeping a good reward over time.

The Businessman, however, knows that owning stock is like owning a business. He does a good deal of research on each purchase he makes, and he makes sure to understand the business model of each company he invests in.

When purchasing a stock, a Businessman will often look at the “fundamentals”, aspects of the company such as earnings, cash flow, debt, assets, and dividends. The Businessman is especially interested in stocks that are priced lower than they should be — either because the company is out of favor (e.g. Ford during late 2008), or because its growth is even higher than expected (e.g. Apple, starting at around the same time). They look down on “di-worsification”, buying stocks in companies without a rock-solid reason for each purchase.

An Academic, however, rarely purchases an individual stock. He concerns himself more with the proportion of various asset classes (large and small, domestic and international, “value” and “growth”, and most importantly, stock and bond) in his quest to balance risk and reward. He believes that in this modern era of free-flowing information, picking an individual stock that significantly outperforms its current price is generally due to luck, and thus that consistently doing so is nearly impossible.

If you’re looking at investing sites on online, you’ll find a lot of Businessmen in the “Motley Fool” community, as well as in the sizable group of those who look to Warren Buffett for their investing inspiration. Meanwhile, the community known as the “Bogleheads” (after Jack Bogle, founder of Vanguard) fall firmly the Academic camp, along with academic researchers exemplified by Eugene Fama and Kenneth French.

Me? I’m an Academic…mostly. The research is compelling, and I trust it more than I do Wall Street or most financial publications. That said, I keep a small part of my portfolio set aside for specific companies to scratch the Businessman itch!

How about you? Are you an Academic, a Businessman, both, or neither?

serenity and the stock market

God grant me the serenity to accept the things I cannot change,
Courage to change the things I can,
And the kind of money where I don’t really care either way.

OK, not really, but yesterday’s announcement that Apple would be giving some of its tens of billions of dollars back to its stockholders in the form of buybacks and dividends sparked a conversation with a friend of mine, so I thought it would be a good time to talk about emotions and the stock market.

Anyone with spare cash will often find themselves invested in the stock market. Those who are compensated partially in stock (hello, fellow engineers!) pretty much have no choice. And everyone will, sooner or later, find themselves selling that stock at a particularly bad time, and slapping themselves in the face because of it. “If only I had sold sooner/later!” How do we avoid this?

First, know that you’re going to get it wrong sometimes. People have varying takes on how efficient the market is, how predictable it is, and how much it’s just a random walk (see Burton Malkiel). I side with the random walkers, but pretty much everyone admits that there’s some amount of “noise” in the market, some amount of movement that you simply cannot predict without getting lucky. Accept that and move on. Yes, you could have timed things better, or put more into this stock when it was low, but you didn’t have a crystal ball, so don’t beat yourself up over it.

Accept that you are heavily biased. Humans have all kinds of cognitive biases, and most of us refuse to believe that we’re affected by them. A particularly deadly one is the fact that we tend to “accept wins at face value and tend to explain away losses”, per this paper among others. In the stock market, this encourages us to take more risk than we really should, and to overestimate our skill. The first step to countering this is to acknowledge our weaknesses. The second step?

Develop a plan, stick to it, and leave your emotions at the door. Do NOT go with your gut; when it comes to the stock market, your gut is lying. Make a plan: I will buy at this predetermined point, and I will sell at this point. (“Dollar-cost averaging into a broadly diversified portfolio and regularly rebalancing” is a good start.) If the market starts plummeting or soaring, keep ignoring your gut: following the crowd is a recipe for buying high and selling low. (And make no mistake: blindly doing the opposite of the crowd is almost as bad.)

Diversify. There’s a common saying in the financial planning world: diversification is the only free lunch. If you have individual stocks, keep them under a small percentage of  your portfolio (say, 5%), and during your regular rebalancing session, make sure they don’t exceed that percentage. [Edit: This means the rest should be in a diverse allocation of mutual funds. I’ll talk about that more in a future post.] This has several advantages: it will help you limit your risk of a single company causing your portfolio to nosedive, it’ll help you sell the winners at a good time, and it’ll help you obsess a little less over your company’s fortunes. Speaking of which:

Don’t own stock in the company you work for. Unless stock options are your main form of compensation, you’re already heavily invested in your company: they’re the ones writing your paycheck! Don’t double down, even if you work for Apple: if your employer gives you stock, in the form of options or ESPP’s, sell it as soon as it vests and invest it elsewhere. (Worried about taxes? You shouldn’t be. I’ll cover that in a later article.) For every story of an employee who retired rich off his company’s stock, I can give you 10 (at least!) of employees who wiped out their wealth by failing to diversify in this way.

Above all: unplug, unplug, unplug. Watching “Mad Money”, reading articles like “5 Stocks To Watch”, and the like will just give you heartburn and tempt you to ditch your plan. They certainly won’t help you make money; make no mistake, they’re entertainment. Following the latest trends just leads to buying high and selling low, because there are thousands of people watching and reading the exact same media. Get the information it takes to follow your plan, only as often as your plan requires. (Hint: if it involves checking prices and other research more than once a quarter, it’s probably too involved.) If you think you may want to change your plan, force yourself to go slowly: wait until next quarter — or next year! — before even beginning to implement that change.

In other words: mind the gap.

shark-infested waters: hiring a financial advisor, part 2

So now you know all about the difference between and RIA and a CFP (and that you should choose an advisor who is one if not both of the above) thanks to last week’s post. But almost as important as their certification level is how exactly they get paid. Yes, both RIA’s and CFP’s have a fiduciary obligation to you — which is definitely a step up from, say, a stockbroker — but financial advisors have developed a reputation for coinciding their best interests with yours, while following the strict definitions of the law. As they say: follow the money. Financial advisers are generally paid in one of three ways: hourly/flat fees, retainer fees, and fees plus commissions.

Hourly/flate-fee: Like lawyers, CPA’s, and many other professionals, some financial advisors charge an hourly rate for their services, or a flat rate for a financial plan. That’s it. They have no vested interest in selling you a particular product, nor do they care whether you have a thousand socked away or a million — their only interest is in doing right by you, so as to get your referrals and repeat business. That said, if you only have a thousand dollars to your name, paying five hundred dollars or more for a plan — a not-unlikely scenario — might not make sense.

Retainer fee: While retainer fee advisors also have no vested interest in selling you a particular product, they do care how much you have in your investment accounts — quite a bit, as they charge a percentage of your assets on a yearly basis (and will generally have a required minimum of several hundred thousand dollars). Generally, it amounts to 1%, with the percentage becoming lower as your account balance goes higher. In return for this fee, they manage your assets for you, leaving you to focus on other things. There are two potential issues with this: for one thing, 1% is a deceptively low number, but when compounded over time can really eat at your total returns. The other problem is more insidious: by handing over the keys to your wealth, the temptation is to just “let them handle it” and disengage from how your wealth is handled. Not only is it not the most responsible thing to do, but as 2008 showed us, it can be downright dangerous.

Commision-and-fee: Another term for this is “fee-based”, which can be somewhat misleading. These advisors generally charge an annual fee — one much lower than that of a retainer-based advisor — but on top of that, they are also paid commissions by mutual fund and insurance companies to sell their products. Most advisors associated with big brand names, like Ameriprise (formerly American Express Financial Advisors), Wells Fargo Advisors (formerly A.G. Edwards), and Edward Jones, follow this model. The potential for conflict of interest is clear, and while some shops steer the straight and narrow, others have developed a reputation for heavily incentivizing their advisors to push high-margin products (e.g. Variable Universal Life insurance policies) onto customers that would be better served through other vehicles. Translation: beware, here there be dragons!

So: from my descriptions, you might think that I’m a big fan of hourly-fee advisors — and that’s not untrue. But while it’s easy for someone to paint all advisors who fall under a certain category with broad strokes, it really all comes down to the individual. You could get an incompetent or unscrupulous hourly-fee advisor, or the world’s best commission-based advisor. And to be honest, a good commission-based advisor could be the most cost-effective, if they point you towards low-cost, no-load mutual funds. But if you’re looking to avoid conflict of interest and remain engaged with your assets, I strongly recommend hourly/flat-rate advisors. 

(Full disclosure: as part of my financial coaching services, I myself serve as an hourly-rate RIA. However, I’m not recommending them because I am one; rather, it’s the other way around. I chose to go this route specifically because this was the only way I would feel comfortable charging for investment advice.)

So how exactly do you find a good advisor? If you don’t already know one, there are two fee-only networks I recommend: NAPFA — the National Association of Personal Financial Advisors — and the Garrett Planning Network. Pick out several in your area — not necessarily in your neighborhood, you won’t be visiting them that often — and look up their Form ADV’s. You’ll be able to get a lot of information there (like how long they’ve been in business, their cost structure, and how many clients they have) that you can use to narrow down the list. Don’t make a final choice until you’ve at least talked to them on the phone. Ask them to explain their investment strategy to you, and how they generally handle cases such as yours (due to confidentiality, they won’t be able to give you specifics). See if they listen as much as they talk.

shark-infested waters: hiring a financial advisor, part 1

Last week’s post notwithstanding, everyone’s financial situation is different; sooner or later you’re probably going to want to consult a financial planner. However, the financial services industry has such a bad rap that a lot of people I know have opted for doing the research themselves, with varying degrees of success. (I can’t tell you how many engineers I know invested in a “sure thing” — Dutch auctions, municipal bonds, a bevy of stocks picked by a program they wrote — that promptly collapsed in 2008.) If you don’t have the time, inclination, or trust in your own financial wizardry, you’re going to want to hire a planner. But how to find one that won’t take a huge bite (as it were) out of your investments?

To answer that question, first let’s take a quick look at the two designations: RIA/IAR and CFP.

Registered Investment Advisor/Investment Advisor Representative:

The terminology here is a little bit confusing. A “Registered Investment Advisor” can refer to either a company or an individual in business for themselves; in either case, it means that they have registered with the SEC or state securities board and are licensed to give investment advice. (“Investment Advisor Representative” is the term used for a licensed individual working for an RIA.) Important things to note about an RIA(or IAR — from now on, when I say “RIA” assume I mean “RIA or IAR”, unless I explicitly state otherwise):

  • You don’t necessarily have to be an RIA to give investment advice. I won’t bore you with the details, but your accountant, broker, or lawyer can legally give you “incidental” investment advice without being an RIA. So if they do, don’t assume anything about their investment credentials.
  • They have passed one or more tests regarding their investing and legal knowledge. Exactly which test varies depending on whether they also intend to act as a broker — it could be a Series 7, 63, 65, 66, or some other. Not only does it cover investing, but it also ensures that an RIA knows exactly where their legal boundaries are.
  • They are held to a fiduciary standard. This means that every recommendation they make must be in the client’s best interest; their ultimate loyalty is explicitly to the client. Any potential conflicts of interest must be made clear through their brochure (see the next bullet point). Contrast this with the “suitability” standard, to which brokers are held, which states that recommendations must not be “unsuitable” for the client; however, their ultimate loyalty is to the broker-dealer company they work for. As you might imagine, this subtle distinction can make quite a bit of difference.
  • You can look up their information online in a centralized database. The online search tool is called IAPD, and it’s a great way to check up on an RIA or IAR and see if they’ve committed any past indiscretions. If you look up an RIA, you’ll get a “Form ADV”, which outlines everything you ever wanted to know about their practice (and a lot you probably didn’t). The bit of awesomeness, however, is that RIA’s are required to create what’s called a “brochure” for part 2 of the Form ADV, which must be in layman’s terms and must contain certain information, including details on any possible conflicts of interest. If you’re wondering about commissions your RIA might be getting for certain investment products, this will lay it out.

Certified Financial Planner

Whereas RIA/IAR is a legal designation for dealing with government bodies such as the SEC or state securities boards, CFP is a private, professional certification.

  • CFP’s must meet certain education requirements. This includes having a bachelor’s degree, taking a very specific set of coursework on various financial planning topics, from insurance planning to estate planning, and a prescribed amount of continuing education each year.
  • CFP’s must have three years of financial planning experience. 
  • CFP’s are also RIA’s/IAR’s. So you can look up their information in the IAPD database, and they’re held to the same fiduciary standard, in addition to a Code of Conduct enforced by the CFP Board.

Now you know a bit about the designations financial planners use. There’s more to a planner than their designation, however — next time, we’re going to talk about how different types of planners make their money. It’s more important to you than you might think!

investing for retirement: just tell me what to do!

Some people love to dive into new subjects; they take a hankering to learn about, say, computers, and the next thing you know they’re telling you stories of DEC and Xerox with stars in their eyes.

Some people, however, can’t be bothered. They want to know what a decent course of action is, and all they care about is that the advice comes from someone they trust. They don’t want to know the whys and wherefores; they just want something that works. They’re busy folk, and they have better things to do.

This post is for them.

If someone stopped me on the street and asked me how to invest for retirement, this is probably what I would tell them. I’m not going to go into details here; rather, I’m going to cover things in as broad strokes as I can, in order to cover as much area as possible. There will be posts in the future that hash out the details. (If you leave a question in the comments, chances are I’ll post about that sooner, rather than later.)

Standard caveats apply: your mileage may vary, you take responsibility for your own actions, and 2008 may in fact happen all over again.

Ready? Let’s go.

How much money should I put away for retirement? If you have any debt that’s at a 9% interest rate or higher, the answer is 0. (Possibly if you have debt at a lower rate, too, but 9%? Get out of town!) “Invest” that money in paying off your debt.

Second, think about what would happen if you were to die or become disabled. If there are people depending on you, strongly consider term life insurance and/or disability insurance, respectively, to cover you until you reach retirement age. (Yes, these subjects will eventually have their own posts.)

Once the high-interest debt is gone and you’re comfortable with your insurance, save up to the limit of your employer’s 401(k) match.

After that, things get tricky; this is one of the most individual aspects of saving for retirement. Here’s a rule that will work for most: whatever you’re saving, increase it by 0.5% of your total income every 6 months. (If you’re rapidly approaching retirement and have ground to make up, and/or have a lot of disposable income, shoot for 1% or higher.) The increases are small enough that you won’t feel like you’re sacrificing the present (and your youth!) for the distant future, but over time you’ll start putting away truly impressive amounts of cash.

What vehicle should I use for the money — 401(k), IRA, brokerage, what?

First rule: contribute to the limit of your employer’s 401(k) match. As anyone will tell you, it’s free money.

Second rule: if at all possible, put it in a tax advantaged account. That means no non-IRA brokerage until you’ve maxed out everything else.

Beyond that, the choice is less important. In general, a good order is this: 401(k) to match, Roth IRA (if possible) to max, 401(k) to max, brokerage account.

Finally: what should I invest in?

Take a stab at what age you can reasonably retire. If you have no earthly idea, 65 isn’t a bad number. Figure out what year it will be when you turn that age. Round up (to a later year, and a higher stock-to-bond ratio) to the next higher multiple of 5 if you’re feeling aggressive; round down (to an earlier year, and a lower stock-to-bond ratio) to the next lower multiple of 5 if you’re feeling conservative. As an example: If I’m 34 this year and pick an (arbitrary) age of 65 at which to retire, that will put me at (2012+(65-34)=)2045 or 2040.

Next, put your money in a target date retirement fund for that year. If your money’s in a 401(k), that’s easy; you’ve only got one option for any given year. If it’s in an IRA with a big brokerage like Schwab, Fidelity, T. Rowe Price, or Vanguard, use their funds (e.g. Fidelity Freedom Funds or Vanguard Target Retirement Funds): generally, you’ll be able to invest in it with little or no fees (beyond the expense ratio, of course). If you don’t have a brokerage, or don’t like yours, I highly recommend Vanguard (and no, I don’t have any relationship with them, other than using them for our personal accounts). If you don’t have the minimum for a given fund, put the money into an online savings account (e.g. ING Direct) until you do.

That’s it. No, really, it’s that simple. As I said, your mileage may vary, but the advice above will get 90% of you 90% of the way there. Is it what I would advise if you were to hire me to take a look at your situation in particular? No. But it’s not far off, either. (And yes, there will eventually be a post on how to handle your investments/withdrawals in retirement, which is a whole other matter.)

Questions? Let ’em fly.