This page has been written exclusively for StockExchangeSecrets by David Hood, author of Beginner-Investing-Made-Easy.com. Thank you David. We hope that you find it to be valuable to your thoughts about retirement planning.
What Is The Easiest Investment Strategy?
Use target retirement funds to invest your money for a specific time frame. Target retirement funds are intended to make it very easy for someone to put money away for a specific retirement date. The fund automatically is more aggressive (more stocks) the further from the target date and less aggressive (more bonds and cash) the closer you get to the target retirement date.
Furthermore, the funds diversify your investments across broad stock and bond index funds. They usually will have part of the money in international funds as well, so you'll get additional diversification. It is hard to be more diversified. That is, after all, the point. You don't want your retirement fund to be susceptible to being wiped out if one industry or type of investment has a hard year or 10.
Can I really do that? Yes. Yes, you can. Its not illegal or sleazy either. I know it is counter intuitive because of the name of the funds, but it really is OK for many reasons.
First of all, why would Vanguard or any mutual fund company that carries target retirement funds care if you're saving for retirement or some other goal? They don't care. They still get the same fees regardless whether or not you are actually planning on retiring at the set date. They are not enabling you to break any laws or regulations.
Second, the government doesn't care either. It is not like these funds automatically get a tax advantaged status even if they are outside of a tax advantaged account -- like a Roth IRA or 401k. You can still buy these funds in a regular mutual fund investment account and pay your taxes just as if it were an index fund. The government still gets its normal cut.
Third, and probably most importantly, there is no law that says you have to wait until after you are 59 and 1/2 to retire! Many people plan on retiring early and, again, there is nothing wrong with that. You can plan on retiring at 45 and put all your money in a target retirement fund for when you will be about 45 and no one will be able to stop you. Rightfully so! Note: If you choose to retire early, you may want to split your money between two target retirement funds. One in a tax advantaged account for after 59 and 1/2 and one in a non tax advantaged account. Hopefully, you live to be well past 59 and 1/2!
What are the advantages of this investment strategy? First and foremost, as the title of this page states, it is really easy. You would need to dedicate 1 to 2 hours up front to set it up -- maybe less if the mutual fund company makes it easy like Vanguard does. From there, you can set up an automatic investment plan so you can dollar cost average. Then from there, you may spend literally zero time on it until you are ready to pull the money out. The only real update might be to adjust your automatic investments once a year if you wish. That can take as little as 5 minutes.
Many people spend 10 - 20 hours every week managing their investments -- checking, researching, analyzing, etc. I used to do that as well. I compulsively checked the stock market multiple times a day and had a sophisticated set of notes about all the investing opportunities out there. All this work is completely unnecessary. Not only do statistics show that the extra work does not make most people extra money, but there is about an 80% chance that it will make you less money! How is this? Mostly it is due to costs incurred by frequent and/or emotional trading. For this microscopic effort you also get great diversified investments. In most cases, your portfolio will consist mostly of very broad US Stock and US Bond index funds. Many, including Vanguard, also expose you to an international fund to give you further diversification. Diversification means safety. It prevents any single company -- or even industry -- from taking your portfolio down with it. Therefore, you can sleep well at night knowing that your money is safe and very likely to increase over time.
Generally you have very low fees and no commissions (at least with Vanguard) with any target retirement fund. Therefore, you can invest slowly over time and not incur additional expenses. Again, expenses are a huge long-term killer of gains. A yearly difference of 1% can take a HUGE bite out of your investments. For example, $10,000 invested over 30 years at 8% CAGR gives you $100,626.
However, if you incur 1% costs every year that $100k is reduced to $76,122! 1% yearly growth reduction turned into a 25% reduction in your final investment value! This is the primary reason that frequent traders who incur regular commissions have trouble beating slow and steady index fund investors. It is not impossible, but it is very hard. One of my favorite advantages of balanced mutual funds that hold primarily index funds is that they automatically buy low and sell high. Even though, everyone knows that this is what you want to do most people actually buy high and sell low due to emotional investing. How does this magic happen? Through automatic re-balancing. Let's say your portfolio is supposed to be 50% stocks and 50% bonds. A few months after you've bought, stocks have fallen in price by 10% and bonds have gone up by 5% (stocks and bonds usually move in opposite directions). Now stocks would be 46% of your portfolio and bonds 54%. Your portfolio would then, assuming it is re-balancing time, sell off enough bonds and buy enough stocks to get the balance back to 50-50. You will have just sold stocks at a low point to buy bonds at a high point. One of the biggest advantages of this investment strategy is that it is about as worry free as you can possibly expect. You know that your asset allocation is intelligently set without you having to ever try to change it. You know that no single market condition is going to ever take out your portfolio. You know that not many people are going to outperform you.
What are the disadvantages of this investment strategy? Target retirement funds are a little bit aggressive due to needing money for a long time. Many live for retirement over 30 years nowadays!
Therefore, the money needs to last for potentially many decades, so people in retirement can't move all their money into very conservative investments as soon as they retire. This can be fixed by buying a fund that is earlier than your target date. If you need your money really soon and will want to spend it almost immediately, then just use a money market account instead.
Investing this way is boring -- just as true, prudent investing should be. You can't brag to friends about the high flying stocks you bought that tripled in 6 months. Being greatly diversified means that you don't get huge gains to brag about. Prudent investing is not supposed to be emotional. Speculating is emotional. I know it is hard not to be emotional when, for example, your portfolio value drops by 30% over a 1 year period and you're retiring in 5 years without a huge pension.
However, if you have prudently invested, you can feel secure in the fact that you made the best decision you could with imperfect information. For example, if someone were to offer me a $1,000 prize if I could guess a coin flip and it only cost $100 to enter, I would do it as many times as I could! However, let's say I only have one chance and I lose. Well, I still made the right decision even if the outcome didn't work out for me. Being boring is actually more of an advantage if you let it be one. Keeping your emotions in check is one of the best things you can do for the long-term success of your portfolio. Target retirement funds help keep your emotions in check. Emotional investing is one of your biggest enemies. Emotions cause people to buy high when everyone is enthusiastic about stocks (dot com bubble) or an industry and sell low when everyone is pessimistic.
Ultimately, the disadvantages are easily overcome by the massive advantages Is it really as easy as it seems? Yes. With most mutual fund companies you can setup automatic investments for free (no commissions). Try not to get too bored. Again, intelligent investing should be boring.
How do I get started on this investment strategy? I recommend using Vanguard. I personally use Vanguard and can vouch for their ease of use and all their funds have a rock bottom expense ratio. You will need at least $3,000 to get started. You may use other mutual fund companies -- most will have target retirement funds. However, I seriously doubt their expense ratios are better. Expense ratios will most likely be your biggest determinant to success with this strategy.
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