Rule Your Wallet Blog

This is my attempt at a simple explanation of the different types of retirement investment strategies. I will write more in-depth articles on each of these topics soon. Most people suggest the younger you are the more growth stocks you should have and moving toward income investing as you near retirement.

Income Investing

The freight train, slow to get moving, but unstoppable once at full speed. Considered by many to be the most conservative type of investing, it is considered one of the safest ways to amass wealth over the long-term. Many people think of this method only used by people at retirement age, but that is not the case. The key idea behind this investment strategy is that all of your investments generate some type of income. This includes bonds, stocks paying dividends, and master limited partnerships. You will find traders moving to this type of investment strategy in a down market because they know they will get x% return on their portfolio.

Value Investing

Easy to comprehend, but it takes a lot of number crunching. Think Warren Buffet for this one, it is his specialty.  The idea of value investing is looking for a stock that is undervalued by the market. To do this type of investing you must do technical analysis of the stocks income statements, balance sheets, and cash flows. (The good information is in the cash flows). Most value investors start with the price to earnings ratio (P/E ratio) when deciding if it is worth it to dig further into the financial statements of the company. Generally, you want to compare the P/E ratio of all companies in a sector as a starting point.

Growth Investing

Looking for the home run. The big winners of the stock market, but some say playing the lottery. This strategy is focused on buying small to medium companies in the United States or stocks in emerging markets (Brazil, Russia, China, India..etc). You can think of tech stocks before the bubble burst. This is a method that many people like, I can understand it, I have bought stocks that have double in price in a few months. I have also bought stocks that have lost half their value in a day. (Netflix) As with all investing, big returns are shackled to big risk.

So, which retirement investing strategies is the best? It depends on who you ask, but I can guarantee you will never get the same answer. What is my advice? Simple, invest in a way where you can sleep it at night. Learn where your risk tolerance is and stay within your comfort zone. The only way to loss is to not save and invest for the future.

There are several ways to allocate your retirement investments. I have listed them in order of difficulty with an explanation and the management fees associated with them. (Management fees are shown as the percentage of you total account balance)

Target Retirement Funds

These are by far the easiest ways to invest for your retirement. You decide the year you are going to retire and find the right target fund. The funds are generally spaced in 5-year increments 2040, 2045, etc.

The funds are diversified based on the target year of the fund. This simply means that the fund automatically moves your investments from mainly stocks over to bonds and cash equivalents gradually over time. The company that manages your fund picks a mix of stocks and bonds that will give you the best returns with the least amount of risk. In the end, you portfolio is mainly bonds and cash equivalents.

When my wife asked me to set up her ROTH IRA, she told me not to put it in anything too risky. So, all of her money is going into a target retirement fund. Only one portfolio to view when you login to see how you account is doing. Easy, Quick, and low stress.

Target Retirement Fund Fees: Expect to pay 0.7 – 0.9%. Vanguard is the best option, their fees are around 0.22%. Picking Vanguard saves you 0.5% right of the bat.

Index Funds

Index Funds generally contain all or most of one particular type of investment. These investments can be the entire stock market, a mid-size company index, a small company index, an international index, an emerging market index, a government bond index, a corporate bond index, a real estate index fund and many others.

Building your retirement portfolio with index funds is a little more difficult than purchasing a single target retirement fund. This is because now you are in charge of diversifying your portfolio. The rule is the younger you are the less bonds you own, the older the more bonds you own. To determine what percentage of your portfolio needs to be stocks, I have seen many different “rules.” The older rule I have seen is 100 minus your age. I have seen this go as high as 130 minus your age. For the older rule: If you are 32 then 100-32 = 68% of your holding should be stocks. To me this is too conservative. I use 120 minus my age. The most important thing is to stay within your own risk tolerances.

It is possible to have a completely diversified portfolio using as little as 3 to 5 index funds; however, you must make sure that you are very well diversified. To do this, I suggest making the Total Stock Market index your core investment. After that, do some research on funds and diversify.

Index Fund Management Fees: I would not pay more than 0.3% on any index fund. Some funds are as low as 0.09%

Mutual Funds

For retirement planning purposes, you use the same type of strategy as with index funds. The difference here is that mutual funds are already diversified somewhat, so it makes hitting your allocation target more difficult. Mutual funds also cause tax problems if they are not in a ROTH IRA and a 401k due to the fund managers buying and selling all year.

Finally, the biggest problem with Mutual funds is that the average management fee is 1.5%. It is possible to build a diversified portfolio using funds that have fees of 0.5% – 0.9%, but that is going take much more research. It is going to take much longer because you need a minimum of 12 mutual funds in your portfolio to diversify properly.

Mutual Fund Management Fees: These can range from 0.5% to over 2.0%

My advice:

Invest in a Target Retirement Fund if you want to save for your retirement but do want to stress over allocations and rebalancing. Use a Vanguard fund to keep the maximum amount of your money.

If you are the more adventurous type that wants to put in a little or a lot of research, go with index funds or mutual funds. Just remember to keep the management fees as low as possible and diversify.

Try this. Contribute just 1.0% and see if your finances can handle the decreased income. Your employer will probably throw in an additional 0.5% to 1% matching contribution. Try this for 6 months or a year. If putting that 1% did not affect your daily life, up your contribution to 1.5% or 2.0%. Repeat this process until you are receiving the maximum matching contribution from your employer.

What do you do once you reach this point? Open a ROTH IRA.