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!

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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.