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Long Term Investment Strategies for Retirement or other Monies

Many of our clients have retirement accounts: 401k’s, 403b’s, IRA’s, Roth IRA’s, or some other type of long term investment account. Under the Bankruptcy Code, we can usually construct the exemptions so that these assets are excluded from the Creditors.
 
Too many of our clients do not get proper guidance for investing these long term monies. Furthermore, we have many clients, especially children, who need a trustee for long term monies. I have managed children’s trusts and special needs trusts for decades for many clients.
 
This article is intended as a primer for folks who need to begin to understand, or who need a refresher on understanding, how to handle long term money. What do we mean by long term money? I mean money that is really not needed for years; more than 10 years. Money that is put away for retirement, for example, that will not be touched for painting the house, sending junior to college next year, or buying a car.


For simplicity, we will use the example of a retirement account (IRA or 401k) that is already established. We have had clients with $5,000 asking for advice, as well as $100,000 or more needing guidance. So long as the money is for a long term goal, this is a good place to start.
 
One word of advice before we start is regarding employer matching plans: in a 401k, for example, when the employer “matches” up to a certain percentage. For example, if your employer “matches” up to 3%, you absolutely positively should put at least 3% of your pay into that account. Why? Because, it is a 100% return on your investment! If you earn $50,000 per year, and you put 3% of your salary into the 401k plan, you would be agreeing to have $1,500 withdrawn from your pay and deposited into that account. There are two benefits here. First, there is a tax benefit: you are not taxed on that $1,500. Second, there is the 100% return on your investment: your employer also deposits $1,500 into the account. Even assuming no growth, you have reduced your taxable income, saved $1,500, and, you now have $3,000 invested for the long term!
 
Even if your employer does not have such a plan, or you are self employed, there are numerous vehicles (IRA, SEP IRA, Roth IRA et.) that you can use which are tax advantaged.
 
Ok, what do we DO with those “long term savings?”
 
The first step is to understand risk. There are many types of risk: risk that the investment your money is in going down; risk that the whole market is going down; risk that the dividends your investments are expected to make are not keeping up with inflation; risk of inflation. Books are written on this subject so we look at it from the perspective of Justice Samuel Putnam, of the Massachusetts Supreme Judicial Court. In 1330 he wrote the “rule” that we as trustees still follow. You, as “trustee” of your own monies for the long term, can look at this rule for guidance as well.
 

Do what you will, the capital is at hazard…all that can be required of a trustee to invest is that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.

 
Thus, it would not be prudent to invest all of the long term monies in a speculative stock or mutual fund. Oh the other hand, putting all your long term investment dollars in a US Government bond would offer very low risk.
Many folks say that because of recent downturns in the market, there is “always” too much risk. There are many ways to reduce risk. Asset association, below, is one way; investing in the broad market, below, is another.
 
On the other hand, most folks don’t understand the risk of not being invested in assets that beat inflation over time; investing your hard earned monies for the long term and having less spending power because you invested them in asset classes that earned less than inflation, over time.
 
The second step is examining reward. Why invest in anything beyond US Government Bonds? They are safe. They will only be defaulted on if the US Government goes down. (And, if that happens, not many other investments would be worth anything anyway!) The reason is for additional reward, beyond the safety of government bonds.
There are many “asset classes” which we could write books about; and which hedge fund managers try to exploit for up to the second advances for their billion dollar funds. However, for simplicity sake, we will review the following basic asset classes: stocks, bonds, hard assets and money market accounts.
 
Stocks are shares of ownership in a company. Historically, they offer both the most risk and the most reward. Notwithstanding all of the “news” on TV and the radio, the long term US stock market has grown at close to 10% per year.
 
Bonds represent a loan to the company or government. They offer less risk but lower return over time. The long term return on government bonds is about 5%, with corporate bonds yielding a somewhat higher return. They are “safer” because, absent default, the issuing entity must repay the principal. On the other hand, the reward is lower, historically.
 
Cash reserves, short term government bonds, CD’s and money market funds are excellent for short term money. They generally have the lowest rate of return, below inflation, and are thus not good for long term investing; their reward is lower than the cost of keeping the money in such a fund because of long term inflation. However, they are good for helping balance in asset allocation, see below. They are also an excellent place to park monies that you don’t know what to do with: an inheritance, a distribution from a 401(k) into an IRA, or the sale of a home, for example.
 
Hard assets include gold, precious metals, real estate commodities and natural resources. Harvard University scored highly in investment returns for many years because of their use of hard assets in their portfolios. They recently had 13% of their assets in commodities and 10% in real estate. With commodities and precious metals, the key is supply and demand. With real estate, the key is timing and management; the reward is a function of how well the property is managed. Many advisors instruct investors to stay away. Many 401k plans have no investment vehicles in this asset class.
 
Finally, with respect to reward, there is an additional factor that adds magic to this established fact or rewards for investing: compounding. Albert Einstein, considered the greatest physicist of the 20th century stated that compounding is the “greatest mathematical discovery of all time.” Basically, the math works like this: take the money invested each year, add the interest, and multiply again. Over time, this is indeed a powerful formula. Boston’s own Peter Lynch, when doing the math, notes that if, in 1626, when the Native Americans “sold” Manhattan Island to the Europeans for $24, the Native Americans had invested their $24 in the “market” at 8%, they would have $30 trillion, far more than all the real estate is worth today. (See One Up On Wall Street, 1989, page 54.)
 
The third step is choosing the best Asset Allocation for you.
 
Asset allocation is the mix of asset classes: allocating 50% of your long term monies to stocks and 50% to bonds is a basic asset allocation strategy. You can spend time (and money) on asking professionals how to allocate your assets. You can use various websites. Boston based financial author and advisor Jonathan Pond recommends taking your age and subtracting from 100 for the percentage of equity. Thus, if you are 30, 70% of your long term money would be in stocks, 30% in equity; at age 70, he would advise only 30% of your long term monies in equity. He also says 20% of the equity would be international. We keep most trust monies at Charles Schwab. Charles Schwab’s Chief Investment advisor, Liz Ann Sonders, who I dined with in June 2009 in Boston at an investment conference, advises a higher percentage in international; she also advocated a percentage in emerging market international equity as well.
 
In an excellent 1996 article about asset allocation in American Association of Individual Investors (that I save in my investments ideas folder), they found that for a medium risk investor, approaching retirement (as opposed to a young investor or retired investor), the consensus among Vanguard, T Rowe Price, Wall Street Journal, and the authors of the book A Random Walk Down Wall Street, is: 60% stocks, 30-40% bonds, 0-10% cash.
 
The fourth step: choosing which stock or bond to invest in.
 
For those of you with limited selections in your 401k or 403b plans, you may have it easier than others: there are only a few stock, bond and money mutual funds available. We can’t possibly go into all potential mutual funds here. We can, however, give a few pointers.
 
First, there are usually many tools available through your retirement account provider. Second, there is a wealth of resources on the web, the library and in the financial magazines.
 
Most importantly, however, think of costs. Some funds charge a percentage simply to invest in them, often called a sales load. Some funds charge a marketing fee called the 12b-1 fee. These types of funds should be avoided, if possible, because of these costs. All funds charge an annual fee which is a percentage of assets. The cost can be over 2% per year. That cost can be a huge drag on your investment. Vanguard is renowned for having the lowest costs. John Bogle, who founded Vanguard in 1974, wrote built the whole company on keeping the costs low; the difference between a high cost mutual fund and a low cost fund “are as dramatic as they are simple.” (Bogle on Mutual Funds, 1994, Page 190)
 
Finally, the tried and true advice is to diversify. Sure, Bill Gates got to be the richest man in the US by having all his eggs in one basket, Microsoft stock. And you may be as talented. Most of us aren’t. Thus, spread the risk. We advise investing in a whole market fund, such as a mutual fund that invests in each of the companies in a broad market, to reduce risk. This is considered a wise diversification strategy. Index funds, which track an established “index” of stocks, such as the Standard and Poor’s 500 Index, a combination of the largest 500 companies, and also tend to have the lowest cost!
 
Things not to do:
 
Many folks think that timing the market is a good idea. “You’re a lawyer, or you read Barrons, you know when things are going to go up and down,” clients tell me. I don’t know. Most folks on Wall Street do not know; look what happened in the crash of 2008! The vast majority of sensible advisors stay away from this notion. There are many studies that show that there are a few strategists that can time the market better than others: Mark Hulburt, who on a daily basis, and in his monthly newsletter, compares all newsletters on market timing. See Hulbert Financial Digest, Annandale, Virginia. He has been tracking the advice of more than 160 financial newsletters since 1980. For those that try, it’s a lot of work, and the risk is very high: the risk of not being in the market on those days that it goes up. After all, the overall trend of the market is to go up.
 
For a basis study on this I use the tried and true studies that state, year after year, as follows: if you were to pick the absolute worse day of the year to invest, that is the high for year, and did so every year, over time you would still be better off than almost any other strategy.
 
Things to do:
 
Savings discipline
 
Of the dozens of books I have read on investing, my all time favorite is called Wealth, An Owner’s Manual, by Michael Stopler, published by Harper in 1993. His most profound point, I think, is the notion of the “Savings Discipline.” A financial advisor for many self made millionaires, he notes “most of the people who have become wealthy have been savers rather than spenders….Usually, it is not an obsession with wealth that drives them but just the desire to have a cushion of comfort. Something within them keeps them from spending every last dollar, they build up cash as a consequence.” Stopler, page 60. “People who are now affluent have had the ability over the years to look at a menu of options for their money and make that one unpleasant choice – deferral, doing without, putting aside instead – with considerable frequency.” Stopler, page 54. This is not that hard; so long as it becomes a habit. Putting away a small percentage of your earned income, with the magic of compounding, can have significant results.
 
We intend to update and supplement this posting. If you have questions about how to manage your retirement or other long term accounts, please call us for an appointment.