Protecting your Retirement

There is an interesting article Protecting Your Retirement No Matter Who's President which talks about where to keep your money since taxes will most probably increase with the next president. It is good to know that taxes will have to climb quite high, before the 401(k) is not the best option.

Even if your income-tax rate jumps sharply, the 401(k) will likely be the better bet, calculates Allan Roth, a financial planner in Colorado Springs, Colo. Indeed, if you have 15 years to invest, the 401(k) will leave you with more money, as long as your tax bracket doesn't climb above 33%.

They also suggest a "Triple Play" to put money into your 401(k), Roth IRA (if eligible), and buy stock-index funds in your taxable account.

What's the advantage of all this? If income-tax rates rise, that could cut into the value of your 401(k) withdrawals. If capital-gains rates climb, it will hurt your taxable account. And if the income-tax system is ever replaced with a national sales tax, the Roth will lose its luster. In other words, you've spread your tax risk -- and thus you should be in good shape, no matter what Congress does.

Now, I really doubt that the United States will turn to a national sales tax so for me the Roth IRA is a very good option.

Reduce your Monthly Spending (Volume vs Expense)

The easiest way to increase your savings is by reducing your monthly or day-to-day expenses. A lot of people get tricked by the mindset that saving on the little amounts doesn't matter, and that I only need to save on the big expenses.

Let's consider two scenarios. In the first one, we are going to save 10% on our $15000 car purchase which corresponds to a $1500 dollar savings. Now consider cutting back from your morning and afternoon coffee stop at your favorite place. Let's say that each coffee cost $5 and you get two a day for 50 weeks of the year. If instead of two per day, you are able to cut out the second, either for health reasons or by braving the company coffee pot. This would translate into a savings of $1250 a year. Car purchases don't happen every year, but on average every 5 years. Therefore, you will save $6250 on coffee in 5 years compared to $1500 on your 1 car purchase in 5 years. Consequently, there is a Volume vs Expense trade-off that you need to think about.

This isn't saying that you shouldn't try to reduce your large expenses, but that your small purchases are just as important if not more. Yes, the amount of savings on the inexpensive items does seem "small", but realize that these items are usually purchased in higher volume which translates into a large cash flow.

Investing Advice

A very interesting article: Keep It Simple, Says Yale’s Top Investor provides a lot of useful advice for the personal investor. David F. Swenson manages investments for the $22.5 billion endownment at Yale. In the last fiscal year, the endownment was up 28 percent. Here is his advice for the personal investor:

What should an individual investor do?
Don’t try anything fancy. Stick to a simple diversified portfolio, keep your costs down and rebalance periodically to keep your asset allocations in line with your long-term goals.

Swenson also recommends to keep your costs low and invest in index funds or other ETFs (exchange traded funds) instead of investing in individual stocks.

For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.

He also adds that personal investors do not have the time nor resources to beat the market-managers. His final note is a hard one to follow, but I think will reduce a lot of stress and turmoil since I am in for the long term and not day-to-day.

Mr. Swensen says investors should forget market timing entirely. Once an individual sets up a program, it should be rebalanced quarterly or semiannually, he said, “but it should be disciplined.”
When the markets decline, try not to pay attention, he said.... “If you pursue the sensible long-term policy, look at it over a 5- to 10-year period. Don’t look at five months.”

Exponential Growth

I think a very important lesson for people to learn as early as possible is the idea of exponential growth. Consider an initial investment in a bank of $100. Assume you have a 10% annual interest rate (the interest rate is quite high for a savings account, but it will show the idea better). Now the growth of your initial investment is given by P*(1+r)^(t) where P is the principal or initial amount, r is the interest rate, and t is the length of time in years. Okay, enough math. Now here are the results:

Over the first 20 years the investment grew to $672.75 and over the next 10 years it grew to $1744.9, which is approximately 3 times the value at 20 years. Consequently, when you are trying to save money for retirement, the single greatest epiphany you can have is that you should use time to your advantage. The more you can save at an earlier time the much better you will be when you want to "cash out".

The Beginning

In this blog, I will be maintaining my voyage as I start my retirement savings with a goal of being able to retire well before most. Since I am at the beginning of my venture, I will have a much different perspective as most because I am currently starting to learn the ins and outs of personal savings and finance.

As I figure out different aspects of saving for retirement that I find interesting or useful for young people, I will post them. I will also post different ways to save money as well.

Keywords: Personal Finance, Investing, Retirement, Money, Stocks, Mutual Funds, Index Funds, Exchange Traded Funds (ETFs)