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Hedging Market Risks To Your Retirement

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The current stock market volatility has many wondering how market risks could affect their retirement prospects. Many almost-retirees found, to their dismay, that the market crashed, wiping out retirement portfolio values, just before they needed that money. While the market has been recovering since 2008, the fear of what happens “next time” has many wondering what they can do to hedge some of the market risks to retirement.

Two of the risks that you are likely to run into include the following:

  1. Market crash just prior to your retirement. This could also include a period of a down market. This means that when you withdraw from your retirement account, you are selling investments at a time when you are locking in losses — and you have to sell a higher volume to meet your needs, reducing the amount of investments in your portfolio.
  2. Maturity on some products at an inconvenient time. Your CD might mature just after interest rates plummet, leaving you no option to roll over at the same yield, or a bond might be called early (or mature), while rates are low.

While you can't completely eliminate these risks (all investment comes with risk), you can hedge against them in a way that can help you limit your losses.

Hedging Market Risks

Diversity

The first line of defense against huge market losses is diversity. When some markets are down, others are up. Consider adding a little more diversity to your portfolio in terms of real estate and commodities, in addition to stocks and bonds. You can also look at diversity in terms of foreign vs. domestic investments, and diversity across sectors, as well as adding some dividend aristocrat stocks to help with your income during retirement — even during a down market.

Stagger Your Maturities

Don't invest in a bunch of CDs that mature at the same time, or invest in Treasury securities that all mature in five or 10 years. Choose different maturity dates, and acknowledge that you might need to have a plan for short-, middle- and long-term investing. A CD ladder can help you create a system that allows you to earn the highest possible yields on long term CDs, while still having the opportunity to take advantage of higher rates when they arrive. Choose bonds of different maturities so that they aren't all coming due at the same inconvenient time. A little staggering can help you avoid having to reinvest everything at the same time — and possibly lose out because of it. Also, make sure you have some investments meant for different time frames so that you have a little more flexibility when deciding what to sell, and when.

Extra Income and Emergency Fund Padding

You can also hedge against market risk by planning your retirement income. Look for ways to build up additional income streams, especially passive income streams. That way, you won't have to rely heavily on withdrawing from your retirement investment account during a down market, and you can leave your portfolio alone to try to recover. (Some even recommend certain, carefully chosen annuities to provide income so that you don't have to deplete your investment portfolio in tough market times.) The same is true of having extra emergency fund padding. Look for ways to build up a supply of money that you can draw on without having to sell investments in a down market.

Roth IRA: Emergency Fund?

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I recently found out that one of my associates uses her Roth IRA as an emergency fund. Rather than put money into a low yield savings account, or some other cash account, she uses her retirement account as an emergency fund. Technically, the basics of a Roth IRA are conducive to this arrangement. However, you do want to be careful. Think things through before you use your Roth IRA as an emergency fund.

Why Your Roth IRA Could, In Theory, Be An Emergency Fund

In theory, your Roth IRA works as an emergency fund because of the withdrawal rules. You are actually allowed to withdraw your contributions to a Roth IRA at any time, and for any purpose – no matter your age. This means that you can take money out of your Roth IRA with no penalty or tax, as long as you are only withdrawing money that you have sent to the account through regular annual contributions. As long as your withdrawal amount doesn't exceed your overall contribution amount, you don't have to pay a penalty or taxes. Keep in mind that previous withdrawals count against your overall contribution amount.

Roth IRA Emergency Fund

You do have to be careful, though. Withdrawing from your Roth IRA can cost you if you don't do it right. If you are under 59 1/2, and you exceed your contribution amounts (except in certain cases), you might be subject to a 10% penalty and to paying income taxes on the amount. Make sure you know what you are doing before you withdraw money from your Roth IRA to shore up your finances in the case of emergency.

Opportunity Cost

While you might not have the expenses associated with penalties and taxes when you withdraw your contributions to your Roth IRA, you are still subject to opportunity cost. Remember: The money in your Roth IRA is working for you. You are earning interest at a pretty good rate (depending on your asset allocation and market conditions), and if you withdraw principal, you miss out. You can't replace the time that your money might have spent in your Roth IRA, growing with the power of compound interest.

On the other hand, though, some insist that the opportunity cost comes when you put that money in a low yielding cash account as an emergency fund. Because your money (theoretically) grows faster in the Roth IRA, the power of compounding interest at a higher rate makes up for the fact that you withdraw some of your contributions for emergencies.

Bottom Line

What you decide to do depends on what you think is likely to work best for you, and provide for your needs. If you plan ahead sufficiently, it should be possible to get quite a bit built up in your Roth IRA. Of course, for it to work, you need to make sure you only withdraw contributions in cases of true emergencies. If you use your Roth IRA as an ATM, you could easily remove all of your contributions quickly — and then move into penalty areas where it starts costing you more. Make sure you carefully evaluate your situation before adopting this emergency fund strategy.

Are You Prepared For A Stock Market Drop?

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The last few days have been quit volatile on the stock market. Big drops, big gains, bigger drops, more rallies, and more slides. With all this volatility, some people are in a panic, ready to sell. However, panic selling rarely does you any good when it comes to a long-term investing strategy. Being prepared for a stock market drop isn't about have stop loss orders ready to trigger; rather, it's about being ready to seize the opportunities that come in your way.

Bargain Hunting During Times Of Stock Market Decline

If you aren't maxing out your tax-advantaged retirement accounts, now might be a good time to add a little more. Over the long haul, the stock market has consistently gone up (of course, there's a first time for everything — including long-term stock market losses). This means that if you take the opportunity now to buy more for your retirement account, you have the chance to reap better tax-advantaged gains in the future. This is especially true if you happen to have a Roth account. Those bigger earnings could be tax-free when the time comes to withdraw.

Another way to bargain hunt during times of stock market decline is to look for good quality stocks with solid fundamentals. Dividend investing can be a great opportunity at this time. Many dividend stocks — especially dividend aristocrats — have a history of coming through tough times. These stocks are “on sale” during a market decline, and you can buy more shares for your dollar. This means that you have the chance to reap bigger gains on increases in stock prices, as well as owning more shares that pay dividends. If you want to boost your income portfolio, now might be the perfect opportunity.

Tax Planning During A Stock Market Drop

A down market isn't just great when it comes to bargain hunting. You can also use this as an opportunity to reduce your tax liability. As you know, you have to pay capital gains taxes on your earnings. The good news, though, is that you can offset your gains by losses. If you locked in some investment profits earlier this year, you can lock in some losses now to offset the income. You can use up to $3,000 in capital losses to offset capital gains each year. If your capital loss is more than $3,000, you can carry over the excess to another tax year, so that losses incurred this year can help offset capital gains in years to come.

You do have to be wary of the wash sale rule, though. If you buy the same security again within 30 days (before and after the sale), you will fall afoul of the IRS if you try to claim the loss. This prevents people from selling a stock at a loss and using it as an offset, and then turning around and buying the same (or a very similar) stock at a lower price to profit from later.

Bottom Line

One of the best things you can do for your finances is to order them so that you are prepared to take advantage of opportunities that come in your way. If you are properly prepared, either with capital to buy more stocks while they are on sale or a plan to sell at a loss to offset earlier gains, you can benefit from stock market declines.

Retirement Savings By Age: Are People Saving Enough For Retirement?

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One thing I'm often interested in is to hear about what the current actual savings rates are for people in our country.

What have they saved?  Have they started saving enough?  Will a majority of people in our country be secure enough to retire?  Have people woken up to the fact that their retirement is creeping up on them, and they're going to need a substantial nest egg in order to maintain the same lifestyle?

Today I thought I'd look at some of the numbers that are out there, to see where people are.

Savings Rate By Age

Actual Savings Rates By Age

I came across a study by the Employee Benefit Research Institute where they did a survey of workers to find out where they were with current savings rates, and to see what their confidence was in whether they could retire on what they were saving.

Here is what they found for actual savings rates, by age groups.

Reported Total Savings And InvestmentsAllAgesAgesAgesAges
Workers25-3435-4445-5455+
Less than $10,00046%59%45%44%29%
$10,000-$24,999 10121087
$25,000-$49,999 119131014
$50,000-$99,999 9981010
$100,000-$249,999 149151222
$250,000 or more 11391519
Source: Employee Benefit Research Institute and Mathew Greenwald & Associates, Inc., 2011 Retirement Confidence

What they found was that not many people were likely to have saved very much for retirement.

Most workers have little put away in savings and investments, but older workers are more likely than their younger counterparts to report higher amounts of assets.

Workers today are less inclined than those even 10 years ago to believe they'll have enough money in retirement, and less confident that they'll get enough from Social Security.   Those very confident in the financial aspects of retirement dropped from 22 percent to 13 percent from 2001-2011.

The decline in overall retirement confidence between 2001–2011 is statistically significant across all age groups. Today’s workers are also less likely to be highly confident about being able to pay for basic expenses, medical expenses, or long-term care in retirement. Workers age 55 and older are more likely than younger workers to be very confident that Social Security will continue to provide benefits of at least equal value to the benefits received by retirees today.

Have People Actually Calculated How Much They'll Need?

So while most people really aren't saving that much, and aren't that confident that they'll have enough, does that mean that they're realizing the dire straights they're in and trying to figure out now how much they'll need?  Not necessarily.

Despite approaching retirement age, half of workers age 45 and older have not tried to calculate how much money they will need to have saved by the time they retire so that they can live comfortably in retirement. Nevertheless, the likelihood of trying to do a retirement savings needs calculation increases with age.

So older folks are more likely to figure out how much they'll need, but still only half are trying to calculate the amount they'll need, while the rest are winging it.

Surprising to me was just how little most people think they'll need to retire comfortably in retirement. When all ages are considered over 72% thought they'd need less than 1 million, with 50% thinking they'd need less than $500,000.

Workers ages 55 and older are more likely than younger workers to think they will need to accumulate less than $250,000 by the time they retire so that they can live comfortably in retirement.

As time goes on and we see the cost of living rise, I thin a lot of these folks are in for a rude awakening when either they don't have enough, or something they were counting on like Social Security  isn't there anymore – or not at the same levels they thought it would be.

Working Later In Life

When they were polled more people expected to be working later in life than ten years ago.  In 2001 70% of people expected to be retired by the age of 65.  In 2011 less than 49% expect to be retired by the same age.

Workers of all ages appear to be planning to retire later, on average, than similarly aged workers were in 2001. In  particular, the percentage planning to retire at age 66 or older has increased significantly for every age group

What Does This All Mean?

While I'm not going over all the data in the linked study, I think we can pull some takeaways from this survey.

  • People aren't planning ahead
  • People aren't saving enough
  • People aren't saving early enough
  • People are planning on working later in life, and depending on Social Security to a degree.

It really is a sobering picture to say the least.  If our country does have to take on some austerity measures soon to help cut rising spending, I'm sure there are a lot of people hoping that their level of government benefits aren't cut because most of them have not planned ahead.

What do you take away from this picture? Are you planning ahead for a rainy day, and for retirement?  Have you figured out how much you need, and have you taken the steps to start saving to reach that amount?

Are You Maxing Out Your Tax-Advantaged Accounts?

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As you put together a plan for the future, and as you plan for your retirement, one of the things you should consider is whether or not you are maxing out your tax-advantaged accounts before investing in other accounts.

Part of getting the most out of your money is enjoying as many legal tax advantages as possible. Maxing out your tax-advantaged retirement accounts before turning to other accounts can help you make the most of your resources — and help you build up your wealth faster.

Maxing Out Tax Advantaged Accounts

Saving Money On Taxes

One of the ways you might be wasting money is by paying taxes you don't need to. While you should pay what you owe, obviously, you can keep more of your money by being aware of the tax breaks available to you. Some of those advantages come from the way you plan your retirement contributions. Some of the tax advantaged accounts you can use to save for retirement include:

  • IRA
  • Roth IRA
  • 401k
  • Roth 401k
For “regular” accounts, you can receive a tax deduction for your contributions. You contribute it without paying taxes on it, so the savings in your tax liability can be used now to increase the effectiveness of your investments. When it's time to withdraw your money, you pay taxes on the withdrawals.
Roth accounts, however, do not offer you an immediate tax advantage. You make contributions with after tax dollars. As a result, your money grows tax-free. When you withdraw it, you don't have to pay taxes on it. This means that you don't pay income tax on the gains from the investments in your Roth account. That can be a real advantage later, especially if you end up in a higher tax bracket. Here's a comparison between a Roth 401(k) and Roth IRA.
Before you open a regular investment account, it might be wiser to max out your tax-advantaged accounts first. If you can, max out your 401k, and an IRA, before turning to other investments accounts. Remember that your spouse can have his or her own investment account (including a spousal IRA if he or she doesn't have a job) as well. As a family, try to max out these accounts before turning to other investment accounts. Your money will go further, and you'll get to keep more of it in the long run (provided you're smart about low-fee accounts).

HSA: Another Tax-Advantaged Account

If you have a high deductible health plan, you have another option for a tax-advantaged account. You can make tax-deductible contributions to your Health Savings Account now, and reap the benefits later. If you use the money in the account later, as long as it is for qualified health and medical expenses, you never have to pay taxes on it. After the age of 59 1/2, you can make withdrawals for non-health costs using the same rules as a traditional IRA. You have to pay income taxes on the withdrawals, but, beforehand, you have the advantage of the tax deduction. Plus, your health care dollars can go further if you aren't paying taxes on them.
In the end, getting the most out of your money requires an understanding of your options. As you decide how to invest, consider maxing out tax-advantaged accounts before turning to investment accounts without the same tax benefits.

Vanguard Becomes More Attractive To Newer Investors As They Cut Fund Minimums To $1000 For Many Popular Funds

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One of the most important steps you can take when embarking on your working life is to plan ahead, and start saving for your retirement.   Through the wonders of compound interest, small amounts saved today, can multiply and become thousands of dollars later on.

One of my favorite places to take that first step and invest in the past has been Vanguard.  The reasons?  Their expenses are so low when compared to other companies, and as we all know the expenses that you're paying can make or break your returns.  Also, they have a wide offering of index funds to choose from (which I prefer) and even some of their actively managed funds are very affordable.

Now Vanguard is making their offerings even more attractive to newer investors as they announced this month that they were cutting fund minimums to $1000 for a wide range of their more popular funds.

Vanguard Fund Minimums Cut

In their announcement this month Vanguard announced that for the first time a wide range of their Target Retirement Funds would be having an initial investment cost of only $1000.

To help investors take the first step toward a more financially secure retirement, we’re lowering the minimum initial investment for our popular Target Retirement Fund series from $3,000 to $1,000, effective immediately. Previously, only one of our funds, Vanguard STAR® Fund, had a $1,000 minimum.

The Target Retirement funds are among the most popular at Vanguard because they offer an easy way to have a diversified portfolio that changes your risk level as you get closer to retirement, while having the costs be relatively low.  It's actually one of the main ways we're investing.

Among the Target Retirement Funds affected by the lower minimums:

  • Target Retirement 2010
  • Target Retirement 2015
  • Target Retirement 2020
  • Target Retirement 2025
  • Target Retirement 2030
  • Target Retirement 2035
  • Target Retirement 2040
  • Target Retirement 2045
  • Target Retirement 2050
  • Target Retirement 2055

Also affected in this change are a variety of other funds that are having their minimums lowered and standardized.

In addition, Vanguard is standardizing the minimum investment for Investor Shares of nearly all our other funds at $3,000. Previously, fund minimums for the affected funds ranged from $3,000 to $25,000. This change reduces the minimum investment for 15 Vanguard funds, including some of our oldest and largest actively managed funds, such as the Wellington™ Fund, Windsor™ II Fund, and Health Care Fund.

So most other funds have had their minimums lowered to only $3000, which makes them that much more accessible to the average investor.

Cutting Fund Minimums Should Allow Younger Investors

I've been saying for a while that I thought that Vanguard and others should lower their minimums for some funds to allow younger and newer investors to get into the game earlier.   It only makes sense. Now Vanguard has done just that, and I think it can only be a good thing.

“Investing early and investing regularly are two of the most important things investors can do to help ensure their retirement readiness,” said Vanguard CEO Bill McNabb. “By reducing the investment requirements for our target-date funds, we hope to encourage more individuals to participate in the financial markets.”

Most people should be able to scrape together $1000 to get started, and I think we'll be seeing quite a few people do just that.

Does this change make you more likely to invest with Vanguard?  Have high fund minimums kept you on the sideline in the past?