Friday, October 30, 2009

Structuring Your Simple Portfolio: Part 5 – Simplicity in Rebalancing

Simplicity is the key to your success in investing to achieve a comfortable retirement without becoming a financial expert.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series. Simplicity in making account contributions were discussed in Part 3. Simplicity in increasing contributions was discussed in Part 4; and next up – simplicity in rebalancing your portfolio.


5. Simplicity in Rebalancing Your Portfolio

Target Year Mutual Fund
If your simple portfolio consists of one Target Year Mutual Fund, rebalancing your portfolio is as simple as it can get – you simply don’t do it. The managers of the Target Year Mutual Fund handle the asset allocation and rebalancing for you.

They take into account the number of years remaining until your fund’s target date by gradually increasing the percentage of bonds and decreasing the percentage of stocks held by the fund. All you have to do is keep adding new money to the account.

An Equity Fund and a Bond Fund
If your simple portfolio consists of an Equity Fund and a Bond Fund, rebalancing is a task you should do periodically.

In Part 2 of this series, I suggested an allocation of 60% to your Equity Fund and 40% to your Bond Fund. This is a very conservative asset allocation and if you use it you may choose to keep this allocation permanently.

Set up an annual rebalancing time. For example, rebalance your portfolio every year immediately after your birthday or immediately after Labor Day. It doesn’t matter what date you choose except that you should commit to a date and actually do the rebalancing on schedule year after year after year.

To do the rebalance simply:
1. Determine the value of both of your funds and their combined total value.

2. Calculate the percentage of the total represented by each fund.

3. Calculate the excess value in the fund that exceeds the target percentage.

4. Exchange the excess value into the fund that is below the target percentage.

Example:
1. Your scheduled rebalancing date is the day after Labor Day (no one knows why you chose that date). On that day your 401k account says that your Equity Fund is worth $35,000, your Bond fund is worth 30,000, and the total value of the 401k is $65,000.

2. $35,000 is 53.85% of $65,000 against your target asset allocation for the Equity Fund of 60%.

3. $30,000 is 46.15% of $65,000 against your target allocation for the Bond Fund of 40%.

4. 46.15% is 6.15% greater than your Bond Fund target allocation.

5. 6.15% of $65,000 is $4,000.

6. Move (exchange) $4,000 from your Bond Fund to your Equity Fund.

7. After rebalancing, you have $39,000 in your Equity Fund (60% of $65,000) and $26,000 in your Bond Fund (40% of $65,000).

8. That’s it – you’re done for this year. Do it again the day after Labor Day next year.

Investing for your retirement can be simple. In this series, we’ve explored two of the very simplest portfolio structures. If you have no interest in learning more about investing or no time to devote to such study, these simple portfolios will do an adequate job of accumulating a comfortable retirement nest egg over twenty or more years depending on your annual contribution amounts.

The sooner you get started, and the more you contribute each year, the better your results will be.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Friday, October 23, 2009

Structuring Your Simple Portfolio: Part 4 – Simplicity in Increasing Contributions

With a simple portfolio and a simple strategy you can successfully invest and achieve a comfortable retirement without becoming a financial expert.

Simplicity is the key to success.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series. Simplicity in making account contributions was discussed in Part 3; next up – simplicity in increasing contributions over time.

4. Simplicity in Increasing Annual Contributions Over Time

A simple and painless way to increase your 401k contributions is to save a portion of every raise you get.

For example; assume you started with a 3% payroll deduction to your 401k. A year later you receive a 3% raise; so you increase your 401k contribution percentage from 3% to 4%. You keep the balance of your raise to increase your lifestyle a bit.

The following year you get another 3% raise and you increase your 401k contribution by another 1% from 4% to 5%. After 10 years, your 401k contributions are up to 13%.

You can continue this sequence until you are contributing the maximum allowed by law and still increase your standard of living every year – just not as much as the entire raise would have supported.

On the other hand – if you start early enough - your retirement will be not only secure but very pleasant.

Similarly, if your simple portfolio is in a Roth IRA, you can set your account transfers at some initial amount and increase the amount with each pay raise.

In this case, you will deal in actual dollar amounts – not percentages of your pay.

For example; assume your initial account transfer to your Roth IRA cash account is $100 per month. For the first year you contribute $1,200 and then you get a raise of $200 per month.

You will increase your transfer into the Roth from $100 per month to $200 per month and pocket the other $100 of your raise. Don’t forget to increase the monthly buy (exchange) amount so the money actually goes into your simple portfolio and doesn’t accumulate as cash.

The following year you contribute $2,400 to your Roth and you get a $300 per month raise. So, you increase your account transfer into the Roth from $200 to $350 and pocket the remaining $150.

The next year your contribution is $4,200 – closing in on the maximum allowed $5,000 per year contribution.

When you get your next raise you increase your transfer to $416.66 per month and contribute the maximum $5,000 per year – until the legal limit is increased, then you will again increase your contribution.

Successful investing for retirement can be simple.

The next post will discuss simplicity in rebalancing your portfolio.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Friday, October 16, 2009

Structuring Your Simple Portfolio: Part 3 – Simplicity in Contributions

There’s a lot to learn and know about investing. But, you can successfully invest and achieve a comfortable retirement without becoming a financial expert. With a simple portfolio and a simple strategy you can succeed.

For beginners, and for the uninterested, simplicity is the key to success.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series; next up – simplicity in making account contributions.

3. Simplicity in Making Account Contributions
Absolutely the simplest way to make contributions to your simple portfolio is through payroll deductions to your employer’s 401k plan.

When you establish your 401k account you will also choose a percentage of your gross income that you want to contribute to the plan. Then every payday an amount equal to the percentage of your gross pay (before taxes and other deductions) for that pay period will be withheld and contributed to your 401k account.

The contributed money will be allocated to the chosen investments of your simple portfolio. In the case of a Target Year Mutual Fund 100% of your contribution will be applied to the mutual fund. If you are using an Equity Index Fund and a Bond Index Fund your contribution will be allocated to each according to the allocation percentages you chose when you set up the account.

In Part 2 of this series, I suggested an allocation of 60% to the Equity Fund and 40% to the Bond Fund.

Some employers automatically enroll new employees in the company 401k plan with a pre-selected portfolio and a pre-selected contribution percentage.

Don’t count on that, though. And, even if your employer did enroll you automatically, check it out and make sure your enrollment conforms to one or the other of the simple portfolios.

If your simple portfolio is in a Roth IRA you don’t have the option of contributing through payroll deductions. So, you have to create an effective substitute. The way to do that is:

A. Have your pay direct deposited to a checking account
B. Set up a weekly, monthly or twice monthly automatic transfer from the checking account to your Roth IRA cash account.
C. Set up a monthly purchase of your chosen simple portfolio investment(s) using the money in the Roth IRA Cash account.

Each investment option under the Roth IRA umbrella is assigned its own account number. Cash contributions will probably have to be initially received in a cash account or money market fund which will be one of the investment options under your Roth IRA umbrella.

Then, you will buy or exchange into the Target Year Mutual Fund (100%) or into the Equity Index (60%) and Bond Index (40%) Funds from the cash or money market account.

This is more complex to set up but your bank or Vanguard account representative will do the heavy lifting if you ask.

In either simple contribution scenario above, once you have the payroll deductions or account transfers set up, the whole thing will run on automatic pilot. Just read your monthly and quarterly statements to ensure everything is still running and to watch your balances grow.

Successful investing for your retirement can be simple.

The next post will explain simplicity in increasing annual contributions over time.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Friday, October 9, 2009

Structuring Your Simple Portfolio: Part 2 – Simplicity

Investing and personal finance is so complicated. There’s just too much to learn and know and research. I don’t have time for it. Besides, it’s boring!

I used to think that. I put off investing for retirement for years because of it. And after I started putting money in a 401k plan I borrowed from it and even took early withdrawals paying the income tax and the 10% penalty.

The amount of information and the risk can be overwhelming. But you don’t have to be a financial whiz kid to be successful. You can accumulate a sizable nest egg for a comfortable retirement with a very simple investing strategy. If you start young enough you can retire wealthy and retire early.

For the beginner, and for the uninterested, simplicity is the key to success.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

1. Simplicity in Investment Portfolio
Absolutely the simplest investment portfolio is the Target Year Mutual Fund. This is a mutual fund managed with an objective of moderate growth and mitigating risk by asset allocation suitable to the time remaining before you retire. The fund manager does the asset allocation for you and as the years pass and the target year gets closer the manager reduces the percentage of the fund invested in stocks and increases the percentage in bonds.

Most 401k plans offer a selection of target date funds. Also Vanguard offers a series of target funds with target dates in five year increments starting with 2005 and ending with 2045. They are called “Vanguard Target Retirement 2045 Fund” with the actual target date substituted for “2045” for each fund.

The second simplest portfolio consists of two index mutual funds. Index funds are structured to closely match whatever index they are named for. The two funds in the second simplest portfolio are a total stock market index fund and a total bond market index fund. Vanguard offers both and they are highly regarded. Look for “Vanguard Total Stock Market Index Fund Investor Shares” and Vanguard Total Bond Market Index Fund Investor Shares”.

You will have you manage your asset allocations yourself and rebalance annually. But a simple asset allocation of this simple portfolio is 60% in the stock market index fund and 40% in the bond market index fund.

401k plans rarely offer index funds; if yours does use it, if not, substitute the offering closest to “large cap equity or stock fund” for the stock market index fund. And for the bond market index fund substitute the 401k offering closest to “bond fund or income fund”.

2. Simplicity in Account Types
The simplest account type for your simple portfolio is your employer’s 401k plan. If your employer has one, enroll in it. Many 401k plans, but not all, match a portion of your payday contributions. That’s free money, so if there’s a matching amount you should contribute at least enough to get your employer’s full match.

When you enroll in your 401k plan, select your simple portfolio using the guidelines described in section (1) above.

The second simplest account type is the Roth IRA. To set this up you must choose a brokerage or mutual fund company. For this purpose I recommend Vanguard.

When you set up your Vanguard Roth IRA you will also select the Vanguard mutual fund or funds for your simple portfolio using the guidelines described in section (1) above.

Investing for your retirement doesn’t have to be complicated – it can be simple.

The next post will explain simplicity in making account contributions and simplicity in increasing annual contributions over time

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Special Report: Structuring Your Simple Portfolio

Links to Topics in Special Report: Structuring Your Simple Portfolio

Structuring Your Simple Portfolio: Part 1 - Introduction
Structuring Your Simple Portfolio: Part 2 - Simplicity
Structuring Your Simple Portfolio: Part 3 - Simplicity in Contributions
Structuring Your Simple Portfolio: Part 4 - Simplicity in Increasing Contributions
Structuring Your Simple Portfolio: Part 5 - Simplicity in Rebalancing

Friday, October 2, 2009

Structuring Your Simple Portfolio: Part 1 – Introduction

In the Asset Allocation series I advised choosing non-correlated investment classes for your portfolio; that is assets that don’t go up or down at the same time. I also recommended some specific asset classes. But you don’t invest in asset classes. You buy specific things. You buy shares in a mutual fund, common stock shares, bonds, gold coins, rental houses, government or corporate bonds. And, you buy them in specific types of investment accounts.

In this series, “Structuring Your Portfolio”, I will introduce various types of portfolios suitable for average people. From the very simplest portfolio structure to fairly sophisticated structures for people who enjoy the process of investing and want to make a hobby of it.

I can not make you a professional. I’m not a professional investor myself. Mostly, I’m a self-taught hobbyist amateur. Because I’m self-taught (lots of books, lots of free newsletters, and lots of trial and error) and a hobbyist, I think I can help you get started and help you improve your investing skills and your results.

Before deciding what to buy we should think about where our financial assets will reside. Even this bit can get complicated, but for most people the choices come down to these:

1. 401k (or equivalent) account administered by your employers

2. Traditional IRA accounts administered by a bank or brokerage company

3. Roth IRA accounts administered by a bank or brokerage company

4. Taxable accounts administered by a brokerage company

5. Bank accounts administered by a bank

6. Real assets administered by you

Each of these possible homes for your investments has certain advantages and disadvantages; characteristics largely created and defined by the federal government. The key features of each investment account type are described below. There are many minor features of each type that I’m not going to cover, so these descriptions are not comprehensive.

401k Accounts
401k plans are “tax deferred”. A percentage of your overall (before taxes) wages or salary is deducted from your pay every payday. You choose the percentage and you choose which of the limited number of investment options your payroll deduction buys.

Tax deferred means that you don’t pay income tax on the amount you contribute to the 401k account. You also don’t pay income taxes on any capital gains (increases in the value of the investments you bought) as long as the value stays in the 401k account.

In the end, you do pay income taxes on the money you withdraw from your 401k account – that’s the deferred part.

Traditional IRA Accounts
Traditional IRA’s are also tax deferred. Money you contribute up to the legal limit (currently $5,000) is tax deductable. Since your employer is uninvolved in your IRA the money is reported as income on your W-2 form, but you deduct it from your gross income when you file your income tax (Form 1040). If you withdraw money before you are 59 ½ years old you will be taxed at your normal rate plus 10% of the amount withdrawn early.

You neither report as earnings nor deduct the gains as long as the money remains in the IRA account. But, like the 401k, you pay income taxes on the money as it is withdrawn from the account. If you withdraw money before you are 59 ½ years old, the same 10% tax penalty applies as in the case of an early 401k withdrawal.

Roth IRA Accounts
Roth IRA’s are tax free instead of tax deferred. Contributions to your Roth cannot be deducted from your income tax for the year you made the contribution. But once money is in the account it will never again be subject to income tax even when it is withdrawn.

Taxable Accounts
Taxable accounts are not protected from income tax in any way. You may choose to purchase specific assets that have certain tax advantages, but the account itself conveys no tax advantage. They are typically not covered by any federal insurance program.

Bank Accounts
Like Taxable Accounts, Bank accounts have no tax advantages. They are protected from loss up to $250,000 per account by the Federal Deposit Insurance Corporation.

Real Assets
Real Assets are things like gold coins, $100 dollar bills, houses, or collectables. The only tax advantage is whatever break you get on your income tax rate for a capital gain as opposed to your rate for regular income. Rather than collecting interest or dividends on these assets you frequently must pay for insurance, storage, or maintenance.

Each of these investment account types could have a place in your portfolio of assets and you can use more than one or even all of them. It depends, as most thing do, on your inclinations, your desires, your expertise, your disposition, your age, your risk tolerance, and your financial net worth.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio