The Impending Retirement Crisis

by Guest Contributor · 10 comments

We haven’t even gotten through this crisis yet, and we have another one on the way? Seriously?

That’s what John Bogle–the founder of Vanguard and the creator of the first index fund–would have us believe. And, distressingly enough, the case he makes is pretty convincing.

Last month, Bogle testified before the House of Representatives about the upcoming crisis of failed retirements. His testimony included a number of noteworthy statistics:

We’re not saving enough

The median IRA balance is just $55,000, and the median 401k balance is just $15,000. Sure, if you’re in your twenties or thirties, having $70,000 saved up is excellent. But given that the largest portion of the investing community is the baby boom generation (who are now retired or retiring soon), $70,000 is nowhere near enough.

In short, most people simply aren’t saving enough. In fact, they’re not even close.

An asset allocation nightmare

One of the best things about 401k plans is that we’re allowed some options in terms of how we want to invest our money. Unfortunately (and perhaps unsurprisingly), a significant portion of investors are making rather poor decisions:
Nearly 20% of investors in their twenties have literally zero exposure to equities (stocks) in their 401k. In other words, they’re invested entirely in bonds and money market funds. With no access to the long-term growth provided by equities, it’s practically impossible for an investor to accumulate the money necessary to retire.
At the other extreme, more than 30% of investors in their sixties have greater than 80% of their 401k invested in equities. Such a high equity exposure is dangerous for somebody so close to retirement. I can only imagine how these investors are feeling after the last year in the market.

Delayed gratification? No thanks.

When changing jobs, 60% of all 401k participants cash out at least a portion of their 401k and use it on something other than saving for retirement. Not only are these investors hampering their ability to achieve long-term growth, they’re subjecting themselves to an extra 10% tax that comes with early withdrawals from retirement plans.

Apparently we just can’t wait to spend our money.

What can we do?

You and I aren’t John Bogle. We don’t have a free ticket to speak to the U.S. House of Representatives anytime we want, so we’re unlikely to play a major role in any system-wide investment industry changes. That’s the bad news.

The good news is that we can certainly make efforts to ensure that we don’t become a part of this mess.

  1. Check your asset allocation. Make sure it’s in line with your age, your goals, and how much you’re going to be able to invest each year.
  2. Make sure you’re saving enough. In the past, finance experts tended to recommend investing 10% of your gross income. In recent decades, that number seems to have jumped to 15% as a result of longer average retirements and increased late-in-life medical bills.
  3. Get used to the idea of delayed gratification. Money in your 401k is not meant to be spent before you retire. No exceptions.

What about you? What retirement-savings pitfalls are you taking extra care to avoid? And what are you doing to avoid them?

About the author: Mike writes at The Oblivious Investor, where he reminds readers that long-term investing success has nothing to do with short-term fluctuations in the market. Subscribe to his blog for daily updates.

Lending Club Review – Peer to Peer Lending Site

by David@MoneyNing.com · 55 comments

Lending Club promises high returns for the average investor through peer to peer lending. With every other asset class doing so poorly during the last few years, this review takes a look at this investment option to see if it’s a better option for our money.

Lending Club Sets Fixed Interest Rates

Unlike other peer to peer lending companies, Lending Club automatically identifies each loan with a fixed interest rate that is tied to historic trends, current market conditions as well as the individual borrower’s credit history. This takes a huge variable out of the investor’s decision, an advantage that I welcome.

Lending Club’s Investing Mechanism, LendingMatch

Peer to peer lending isn’t new, but Lending Club is claiming that 93% of investors are getting a return between 6% – 18% (as of August 2012).  In order to get those returns though, you need to invest (or lend) through the system.

Lending Club provides two main ways to invest: picking each note (loan) one at a time or in bulk through its LendingMatch technology.

LendingMatch takes your investments, divides it up into $25 dollar chunks and diversify it across different grades to achieve the average rate of return that you specify. While this method doesn’t really take into account the purpose of each loan, it is a quick way to diversify across many different loans as well as take subjective decisions out of the investment equation.

Rate of Default

With peer to peer lending, the inevitable question of risk comes to mind. Lending Club tries to address this by only approving borrowers that have a FICO score of at least 660. In fact, Lending Club borrower’s average FICO score is well above 700 (at time of review, it’s 713 as taken on their website).

In my personal opinion, the best way to mitigate the risk of default is through diversification across as many loans as possible.  This is because the effect of each default on your individual portfolio is reduced with every additional note that you carry. This bodes well for Lending Club, because the LendingMatch tool allows us to diversify our investments quickly and objectively.

Reinvesting

lending club reinvesting

In order to maximum our returns, Lending Club offers an automated way to reinvest your monthly payments based on the criteria that you set. A minor detail that I like about this is that I can set it to alert me through email either daily, weekly or monthly for true hands off investing.

Is Lending Club Right For You?

The Lending Club website makes many comparisons of bank savings and CDs with its lending program, but I believe that the lending club model is more directly competing with money we have for investing in securities like stocks and bonds. Savings and CDs, while having a low return, is virtually risk free while any other investment carry the risk of capital.

However, peer to peer lending with Lending Club is a very strong contender for our money compared with other investments because of the potential high returns and passive nature (if you let it automatically invest your funds). If you are enable to diversify your investment across many different loans, the potential return seem to be worth the risk.

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Rebalance Your Portfolio in an Unbalanced World

by Guest Contributor · 3 comments

“How do I rebalance my portfolio in this crazy market?”

That was a question I received recently in a long email from James.  He explained that he was a “moderate” investor.  He had a good mix of assets in bonds (of various maturities) domestic & international stocks (small, mid and large cap), and natural resources.

Even though James was broadly diversified, he’s still getting slammed.  He’s lost over 50% of his nest egg and he isn’t happy.  He asked me if he should rebalance now and if so, how?

Why People Rebalance and How to Do It

The concept of rebalancing is meant to help you sell high and buy low.  (The “buying low” isn’t much of a problem these days….its the “selling high” that has everyone stumped).  Let’s consider a simple example.

Assume you originally invested $200,000 and you wanted a 50-50 split between bonds and stocks ($100,000 in bonds and another $100,000 in stocks).  Now, your portfolio is worth only $100,000.  The $100,000 in stocks is now only worth $40,000 and the $100,000 in bonds are now worth $60,000.

To get back to the original 50-50 split, you’d sell off $10,000 in bonds and buy stocks.  If you do this, you are buying the assets that have gotten beaten up the most (buying low) and selling the asset that has done relatively better.

Is rebalancing important now?  It depends.

First, if you are broadly diversified in equities, you probably noticed that everything got creamed last year and isn’t doing so well so far this year either.  Some advisors will tell you that it’s critical that you rebalance right now.  I’d say, right now, it might actually hurt you – at least in the short-term.  Why?  Because the investments that are doing poorly may continue to get whacked.  Nobody knows.

Personally, I think it is very important to be strategic right now.  If you are in the market, stay with high-quality equities.  Stay with short-term high quality bonds too.  This flies in the face of textbook rebalancing and if that bothers you…..don’t do it.  In normal times, rebalancing does make sense….its just that I can’t promise we’re in a “normal” period right now.

If you decide you want to rebalance, beware of two problems: it can take time and it can be expensive.

How can you solve those two problems?

Rebalance once each quarter.  I say this because even if you buy no-load funds, most have short-term redemption charges.  However, in most cases, that penalty is not imposed if you hold the funds for 90 days or more.  That means you can buy and sell at will without worrying about costs.  Please make sure to check your specific funds for restrictions.

If you want to rebalance more than quarterly, you should buy a number of funds in each category and ladder the purchases so the 90 day period expires at different times.  This is a bit more complicated and I don’t have the space to explain it further here. But if you work with an advisor, they can explain this to you.

It will be much easier to rebalance your funds if you keep all your funds at one custodian like TD Ameritrade, Fidelity or Schwab.  As an alternative, you could have all Vanguard funds or all Fidelity funds.  Just don’t have multiple accounts at multiple fund families unless you love the idea of headaches and stress.

If you decide to rebalance, it doesn’t have to be a costly affair.  If you decide NOT to rebalance, that might be ok too.  The bigger issue, I think, is how you approach your money right now.  More than ever before, it’s very important to keep your emotions out of your investing behavior if you want to stay on track.

What Does Fiscal Stimulus Mean?

by David@MoneyNing.com · 18 comments

This is a guest post from Manshu, author of OneMint.com who started writing articles when he was majoring in finance.

With the economy reeling under a recession, the word that you read quite frequently is stimulus. But what is it? First, let’s explore a few terminologies: recession, GDP, consumption among others.

A recession is characterized by the contraction of a country’s Gross Domestic Product (GDP). The GDP sums up the total economic activity that happens within a country and is the sum of the following things:

GDP = Consumption + Government Spending + Investments + Net Exports (Exports – Imports)

Consumption refers to the money spent by private households and businesses on the things that they consume. As you can well imagine, consumption shrinks considerably during recessionary times.

Why you may ask? The number of times you go to a restaurant reduces and so does the number to the grocery store visits. As a result, the income of the grocery store and restaurant goes down too. When that happens, they lay off their employees and those employees further reduce spending. Because of this, businesses are discouraged from expanding and going out on new ventures and the investments in the above equation goes down as well.

Economists call this the fall in Aggregate Demand.

In order to stem this fall, the government launches a spending program to boost the aggregate demand and stimulate spending and economic activity. This is known as a Fiscal Stimulus.
There are various ways in which a fiscal stimulus can be administered but there is no solution that can fit all situations.

The two main ways of providing fiscal stimulus are:

  1. Tax Cuts: By cutting taxes, the government allows people to keep more in their pockets and ultimately spend more. This increases Consumption in the above equation.
  2. Government Spending: Direct government spending in infrastructure, social welfare or other such things increases the Government Spending in the above equation and helps boost the GDP.

When there’s talk about fiscal stimulus, you will sometimes hear people talk about the multiplier effect. What this basically means is for the effect (in dollar terms) of the economy with every dollar that the government spends. Hopefully, this is more than 1 (ie, the economy grows by $1.50 for every $1 that the government spends). There are currently debates on what the multiplier truly is right now and whether it even exists.

There’s also debates on whether tax cuts or government spending programs are better for the economy and I think that this debate is largely unresolved as there is no clear indication that one is always better than the other. What do you think? Do you favor tax cuts or would you rather have the government put more programs in places that they deem of need?

Why You Are Important

by David@MoneyNing.com · 7 comments

Every once in a while, I hear a comment about work that goes something like this:

I’m a nobody anyway and what I do is unimportant.

Actually, nothing is further from the truth.

The Story of the Proud Janitor

One of my friends work in the cleaning business and he loves it. I asked him before why he likes it so much since most people would stay as far away from a job like that as possible and what he said stuck with me till this day. He told me that if he doesn’t do his job correctly, everyone at the office will become sick. His duty is to make sure that the office is as clean as possible and ensure a healthy and pleasant environment for all employees. He went on to tell me that even though no one notices him (since he comes in at night), his job is incredibly important and it actually affects so many people’s lives as the employees are at work for so many hours each day.

The Forgotten Tires

Remember my deflated tires last month? If they were not manufactured to still run safely after it pops, there would be no more updates here because I would probably still be in a hospital (that’s if I’m lucky enough to get there). To be honest, I’ve never really thought much about my four tires but they are actually the only part of the car that touches the ground. Without them, it doesn’t matter how powerful the engine is nor how intelligent the computers are because it won’t be going anywhere.  I can probably play music on it but that would be an iPod that’s too big.

The Invisible Screws, Bolts and Nuts

Screws must be among the top ranked items that people throw away or lose. But what happens to your desk if some of them are loose? How about the chair that you are sitting on right now? Would you like to be in a moving car when the nuts and bolts that is holding the engine tight fall out? Didn’t think so.

As insignificant as screws are, they might be more important than probably your airbag. Hmm…

You are Important

You may feel ignored at times, but trust me when I tell you that you are important. Everyone may feel down sometimes but don’t let that feeling continue.

  • You are the World to Your Children.
  • You are the Love of Your Spouse
  • You are the Joy of Your Parents
  • You are the Leader of Your Mind and Soul

You are important, you are important, you are important.

How to Achieve Predictable Stock Market Returns

by David@MoneyNing.com · 13 comments

The idea that stocks provide fairly predictable long-term returns is one of those fundamental beliefs upon which practically the entire investment industry is based. Lately however, I’ve seen a lot of people questioning the validity of that assumption.

And I can’t blame them. Having your portfolio decline in value by 40% in one year doesn’t exactly breed confidence in the value of holding stocks. Unfortunately, volatility is the price of admission.
However, even with the atrocious results of 2008, the (very) long-term return on stocks is still excellent. For example, for the 25 years ending 12/31/08, the market–as measured by the S&P 500–earned an effective annual return of 9.71%. Not bad.

Here’s the catch: In order to have earned that 9.7% return, you actually had to stay invested in the market throughout the 25 years even when the market was going down. Most people don’t do that.

If you bought and sold several times throughout the period, your return could very well be dramatically different from the 9.7% figure. It could be much better, or it most likely is much worse.

In short, if you jump in and out of the market, your long-term returns become much less predictable.

Looking Ahead

We can say with a fair amount of certainty that market returns for the next 30 years will be somewhere in the 7-10% range. (Based on the “Gordon Equation” of dividend yield + earnings growth, as explained in Bernstein’s Four Pillars of Investing and Bogle’s Little Book of Common Sense Investing.)

What we don’t know, however, is what the market’s going to do for 2009, 2010, or any particular year in the future.

If you want predictably decent returns, then buy an all-market index fund and never sell it. At least, don’t sell it until you’re retired and drawing down on your investments.

Want to take your chances at great returns? Then pick stocks. Jump in and out of the market or switch from fund to fund every year. Just make sure that you’re fully aware that with such a strategy is as likely to harm your return as help it.

About the author: Mike writes at The Oblivious Investor, where he reminds readers to ignore the day-to-day market news and focus instead on getting investment fundamentals right. Subscribe to his blog for daily updates.

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