3 Things You Need to Do (but Won’t)

I had a very interesting conversation this week with a writer/editor from a Men’s fashion magazine.

Not, as you may have first surmised, due to my snazzy sartorial choices  — especially, the many and varied Ted Baker ties I wear when called upon to don a suit for the tube.

No, his question was more financial in nature. This gentleman asked a rather intriguing question, which, this being a quiet Sunday morning, I will share with you.

He said to me:

"I’m not very good with finances — I’m not a numbers guy. Many of my readers are the same way.  We all know we should be doing something with investing for retirement, but we don’t know what to do. Everytime I ask someone, I get a long winded, jargon filled answer. Can you give me three simple suggestions — in plain English — that my readers should do to get started?"

No problem, I said. I have three simple things for your readers to do. These will save them and make a ton of money: Pay off your credit cards, Max out your tax deferred accounts, and start Dollar Cost Averaging into a few ETFs.

I enjoyed the back and forth enough, I decided to make this an Apprenticed Investor column (forthcoming in a few weeks). Meanwhile, here’s a quick preview:

1. Pay off your credit cards: Most people pay have much higher credit card rates than they realize — they creep up over time, especially if you have any sort of a balance. Even a late payments to someone else will also send your rate higher.

Paying these balances off are the equivalent of a guaranteed return of 18% (or whatever your rate has become). RISK FREE, GUARANTEED. You wont get that deal anywhere else.

2. Max out your tax deferred accounts — 401k/IRA: Putting money into these accounts gives you the equivalent of an extra 40% or so investment capital (depending upon your present tax rate), which then compounds over the decades until you take it. When you retire and withdraw these monies (which should have appreciated nicely) you will be in a much lower tax bracket.

3. Dollar Cost Averaging ETFs:  The simplest investment thesis: Set your account up for dollar cost averaging for a few different ETFs. Each pay period (or monthly), but the same dollar amount of your choices. example: $100 of DIA, $100 of SPY, $100 of Qs, etc.

When prices are high, you buy less shares; When prices are low, you buy more. Its pretty foolproof.
   

~~~

I warned the editor that most people won’t do these things. They are like diet and exercise — we know we should, but most of us just don’t. 

Such is the fate of us slightly cleverer, pants wearing monkeys . . .

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  1. Hal commented on Nov 18

    one thought–when you get to 59 and a half, put money into regular accounts and go for long term cap gains and dividends where your tax rate is under 20%.

    In retirement many of our tax rates will be the 39% so we will have converted dividend and cap gains tax rates to ordinary income tax rates.

    Each person will be different so an analysys is appropriate.

  2. MJ commented on Nov 18

    How do I determine which ETF’s to buy? And then how do I know when to sell so that I do not lose money?

  3. Royce commented on Nov 18

    Barry, monthly dollar cost averaging in small lots works with mutual funds, not ETFs, because of the fixed rate of brokerage commissions. Investing $300 in three separate etfs in a single month would require $30 or more of the capital be given to the brokerage house. Not a good start when you could give the same $300 to Vanguard at no cost and get the same or similar indexed exposure.

  4. Hal commented on Nov 18

    Guys:

    this is the KISS method. A lot of folks do not have the interest in this at all (duh) and are not as nearly anal as most of us.

    I like discussing this type of stuff at social gatherings and watch eyes glaze over. Just try explaining the interaction between Bernanke and Paul :-).

  5. Critic commented on Nov 18

    The fourth point that I try to make when I’m asked this question is to match your home mortgage with your retirement age with a fixed term mortgage, so that before you retire, you can stop making house payments.

    This was certainly a staple of my parents’ generation, and one that made perfect sense to me, but for the last several years, I’ve been greeted with derision by people who thought that I should be taking money out of my house for more consumption or investment, and that the new payment was the most important measure of success.

  6. MarkTX commented on Nov 18

    All of this is nice, simple, and good.

    Suzie Orman anyone?

    The biggest factor might be missing….

    Do you have the money to pay of you credit cards?

    If not, then this is not a workable plan.

    One other huge caveat, if your money is in a tax deferred account, you probably cannot touch it without penalty
    (in my case 20 years).

    Sounds nice (and can work) but for most americans is it obtainable????

  7. sk commented on Nov 18

    ============================
    RE:
    Sounds nice (and can work) but for most americans is it obtainable????
    ============================
    So maybe the very FIRST point should be:
    1. Cut down on your expenses and/or increase your income so that the next three points are obtainable.
    2. ..
    3. ..
    4. ..

    -K

  8. RobertM commented on Nov 18

    Please, dollar cost average a mutual fund, not an ETF. A monthly ETF transaction costs at least $100/year, much more than the small tax benefit that some would get from an ETF vs. a mutual fund.

    If they’re looking for simple advice, tell them to put there money into a diversified mutual fund-of-funds that matches how conservative they are, diversifies their investments in one easy mutual fund, and rebalances regularly, like the Fidelity Freedom funds.

  9. Jim K commented on Nov 18

    Re: 401k – “…When you retire and withdraw these monies (which should have appreciated nicely) you will be in a much lower tax bracket.”

    ‘Appreciated nicely’? The word ‘should’ is better replaced by ‘may’ IMHO… Between now and most people under 55 reaching pensionable age, there’s a LOT of big issues that need addressing long before any growth or ‘appreciation’ can happen:

    a) global warming/huge CO2 cuts (forcing huge industrial/commercial cuts plus huge environmental programs)
    b) mitigation of peak oil and peak natural gas
    c) the consequences of decades of debt/credit expansion
    d) worsening demographics – payers vs pensioners
    e) material/mineral/food shortages

    Put another way, the assumptions of growth are not based on reality.

    Paying into a pension is throwing bad money after bad. Bad because it cost the planet (and therefore our futures) to get it and bad because it has (until recently) been invested in other collective future-destroying activities.

    You want future security, invest in your family, community and local landbase. That investment strategy worked for thousands of years.

  10. stjoe commented on Nov 18

    The biggest factor might be missing….

    Do you have the money to pay of you credit cards?

    If not, then this is not a workable plan.

    I once took control of a relative’s finance. He had credit card debt in five figures. I gave him a weekly allowance and made him LIVE ON A PREAPPROVED BUDGET. I got his credit card debt PAID OFF in 15 months and gave him back control.

    A YEAR LATER HIS CREDIT CARD DEBT WAS BACK WHERE IT STARTED!

    You can lead a horse to water, you cannot make him drink.

  11. W.Edwards commented on Nov 18

    I agree with stjoe. Most people have the resources to do what Barry has suggested. The problem is that they don’t have the discipline to do it.

  12. JWC commented on Nov 18

    Agree, and that is what we did… except we had mutual funds. We retired when hubby was 55.

    The first step however, which will fix the issue of having enough money for the other steps, is #1. Live below your means.

    We are doing fine in retirement, though I have to admit I’m feeling a lot of angst regarding the state of our country. Still pay off the credit cards every month.

  13. Marcus Aurelius commented on Nov 18

    According to Chinese television (as reported elsewhere on the internets tubes, and I’m not going looking for it again, so you’ll just have to take my word for it), the best financial move Chinese citizens can currently make is to sell their American dollars.

    Maybe getting out of the dollar should be #1 on this list.

  14. sn commented on Nov 18

    I don’t know about you but I expect to spend more during retirement than now. I also expect that income tax rates to rise over time; therefore, I expect that the tax rate on withdrawals from my 401k plan will be at least as much as the tax rate on my current income. I suspect this situation would describe many of you.

    So, unless you have an employer match to your tax deferred plan, it would be better to forgo the tax deduction and invest in index funds such as the ones offered by Vanguard (low cost) rather than the ones offered through 401k plans (mostly higher cost)

    FWIW

  15. lurker commented on Nov 18

    with company matching on the 401k the returns should be MUCH better than you even show with tax sheltering benefits.

  16. ajw commented on Nov 18

    Well done, Barry. There are all kinds of arguments to be made about implementation (FWIW, I’m completely agreed with others here about the cost-effectiveness of index MF vs. ETF investments) but if most Americans could even get 1/3 of the way through your list we’d be in much better shape. Those of us who love the complexity of talking about this stuff often forget that for the vast majority of people some very simple choices can make 90% of the difference, and it’s that same complexity that keeps them from even engaging with the issue of money in the first place.

  17. DavidB commented on Nov 18

    I always advise to first tackle debt as well. Since a dollar of debt is just like a dollar saved. The only difference is the dollar you pay down on debt is a guaranteed return on your savings whereas you still have to earn the return on the dollar you’ve saved. Not only that but you have to pay that debt with after tax dollars. Let’s say for argument you marginal tax rate is 25%. You would have to earn $1.25 just to pay off $1 in interest. So each dollar you pay on debt in that example(assuming an 18% interest rate card) saves you having to earn $1.47 to cover the dollar you owe plus the interest you’ll have to pay. Where else can you get a 47 cent savings bang for you ‘investment’ buck? You would have to take on a lot of risk to match a guaranteed investment like that.

    Someone might want to check my math on that. It may be wrong but not by much

  18. anon commented on Nov 18

    The current plan is to retire in 12-15 years, when I will be between 56 and 59. If I can keep up my last 12 year’s investing track record, I will have about 25-30K in monthly income.

    I don’t see any possibility that my tax rates will be lower. In fact, quite the opposite. People like me will be the only ones who have any money left to pay off the Republican’s debt.

    I also think people have to look to invest overseas. That is where the growth is going to be in the coming decade or two. I realize that overseas investing makes things “too complicated” for the intended audience, but unless you are a Warren Buffet level stock picker, the US market is going to be a tough place to earn superior returns.

  19. Barry Ritholtz commented on Nov 18

    If you have a wrap account, there is no fee for this.

    The key is that this refers to low cost INDEX funds — not pricey mutual funds.

    Vanguard is an ideal choice…

  20. Estragon commented on Nov 18

    For anyone interested in a critique of the FNM “fuzzy math” story, calculated risk takes an interesting run at it.

    I’m not affiliated with CR in any way… just happened to run across the piece and found it an interesting contrary view.

  21. Andrew Gottlieb commented on Nov 19

    All good ideas, except the third one, which doesn’t make any sense at all. With $10 commissions, you end up spending 10% to invest $100. With a ten percent cost drag you not only won’t make any money, but you will end up very poor in retirement.

    I will assume you meant dollar cost average into index mutual funds. Do this at Vanguard, and you will be just fine.

    Or, there is a solution. Use Zecco.com, which as long as you have $2500 or more, gives you 10 free trades per month. That solves the cost problem.

    I’d add one more, though, to your list of three. After paying down any credit card debt, save enough money in a money market fund so that you have at least 6 months of living expenses in a safe and secure place. Preferably 12 months. This protects against loss of job, illness, disaster, and also allows you the small (but essential) luxury of being able to say “Take this job and shove it!”

    Love your blog.

  22. Andrew Gottlieb commented on Nov 19

    All good ideas, except the third one, which doesn’t make any sense at all. With $10 commissions, you end up spending 10% to invest $100. With a ten percent cost drag you not only won’t make any money, but you will end up very poor in retirement.

    I will assume you meant dollar cost average into index mutual funds. Do this at Vanguard, and you will be just fine.

    Or, there is a solution. Use Zecco.com, which as long as you have $2500 or more, gives you 10 free trades per month. That solves the cost problem.

    I’d add one more, though, to your list of three. After paying down any credit card debt, save enough money in a money market fund so that you have at least 6 months of living expenses in a safe and secure place. Preferably 12 months. This protects against loss of job, illness, disaster, and also allows you the small (but essential) luxury of being able to say “Take this job and shove it!”

    Love your blog.

  23. www.cruelesttax.com commented on Nov 19

    Good post. Does the advice to dollar cost average represent a view that equities are likely to suffer some whackage in the short/intermediate term?

  24. John commented on Nov 19

    MJ asked “how do I know when to sell so that I do not lose money?”. You DON’T sell!!! This is a plan for many years, perhaps decades, during which time the markets will go up and down.

    It’s NORMAL for markets to go down periodically. History shows 10% drops every 18 months or so on average. When you dollar-cost average you TAKE ADVANTAGE of these drops to buy more securities, and that’s how you MAKE MORE money.

  25. ed commented on Nov 19

    Item number 4: Put as little money as possible into cars. They are large, depreciating assets. Pay attention to gas milage, too. I did a quick check on the feasability of trading my Civic for a Jeep to run around town in. Even with that relatively small SUV, the gas cost difference was $9000 for 100,000 miles. It is a lot cheaper to rent a specialty vehicle whenever I want one than to make the trade.

    Figure the difference between trading frequently for your dream car and driving the wheels off the least you really need and see what difference that makes over a 30-year period.

  26. stockkevin commented on Nov 20

    Great list for the typical American.

  27. muckdog commented on Nov 21

    Okay, but another option is not to save a dime and hope that the Democrats pass enough of a social agenda to take care of one in one’s old age. That way, current income can be spent on beer and strippers.

    JUST KIDDING! Sorta.

    But seriously, let me add another idea up there for those of you concerned about paying a higher tax rate at a future date. One can lower the future tax bite by retiring to a state that has no state income taxes. Like Nevada, Florida, Texas… etc.

    In addition, the Roth 401(k) is now available and many employers are now offering that as an option. So money can be taxed now, and saved/invested, then taken out later with no taxes.

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