Wednesday, February 7, 2007

Getting to retirement

Having made it to a happy retirement, I think I may have some insight which will help others get there. Even during my working days, colleagues frequently asked me about investments and other personal finance issues and I enjoyed the discussions. So, I embark on a blog to help those who are interested in planning for retirement, but don't feel comfortable that they have a clear roadmap

So, how do you get to retirement? By maxing out your retirement accounts and managing them well, of course. Ok, ok, I know that seems a bit simplistic, but in reality it is not much more complex than that. Here's the roadmap.

Step 1: Start early. I know when you are young, finances are tight and it seems that the contributions you can make are so small they are insignificant when compared to the retirement goal and the goal seems so far away. Even so, it is important that you begin as early as possible. The dollars you contribute at that stage are much bigger than those you'll contribute later, due to the power of compounding. In addition, it is important that you establish the behavior of regularly contributing before other spending starts to shrink your disposable income. It is true that spending tends to expand to match your income, so paying yourself first, early and often works to your advantage on both the saving and spending side.

Step 2: Keep your hands off the retirement accounts. It is easy to see the retirement accounts as money you can use for other purposes, but tapping them establishes them as a crutch that keeps you from living within your means and therefore cripples your retirement efforts down the road. I know there are circumstances dire enough that you have no choice, but tapping the retirement accounts should be an absolute last resort.

Step 3: Minimize your debt. Debt is another crutch that can contribute to crippling your retirement plan. Debt can easily become addicting and both eliminate your ability to contribute toward your retirement and increase your cash requirements in retirement. If you don't have the cash to buy something after your retirement contributions and other operating expenses, put off the purchase until you do have the cash.

Step 4: Manage your accounts. Here are the critical points in this process.
  • Keep costs low. For me, that means investing in index funds. I know, some will insist that costs are not significant if the investment performs better than average. True, but numerous studies have shown the odds of picking the high performers ahead of time is low. Don't be fooled by those who think they can and attempt to prove it by pointing to investments in the past. It is easy looking backward, but very few can do it consistently looking forward over a long period of time. You can't afford to take that chance. Take the safe road of low cost.
  • Diversify. Various types of investments perform quite differently over time, and it is tempting to try to jump with precise timing into the next high performing group. Don't try it. Again, the ability to make these timed moves such that you improve your returns is extremely rare. Allocate your investments so you are always invested in a diverse portfolio. As a minimum, spread them over domestic stocks (both growth and value), international stocks and bonds.
  • Dollar cost average and regularly rebalance. By regularly contributing to your account and setting them up to invest in diversified investments you put the power of dollar cost averaging to work for you. Ie, each time you contribute you buy more shares of investments at lower than average cost and less of those that are higher than average. Then regularly rebalance to your allocation plan. Voila, you are automatically buying low and selling high, on average. The classic buy low, sell high mantra is correct, but do it mechanically with dollar cost averaging and rebalancing. Trying to do it from the gut, or even with other valuation tools leaves too much room for error and emotion. Because of that, most people that try to buy low and sell high on these basis ending up hurting the performance of their portfolio. It is too easy to get wrapped up in the frenzy and end up doing what everyone else is doing, with disastrous results.

Step 5. Relax. If you follow the steps above throughout your working life, you'll almost certainly retire a millionaire. It is really pretty simple and satisfying.

So, there you have it. Start early. Keep your hands off your retirement accounts. Minimize debt. Manage your accounts by keeping costs low, diversifying, dollar cost averaging and regularly rebalancing. Relax. How could it be simpler!


Toni said...

We are glad you didn't fall off a mountain somewhere and we are glad you hav eresurfaced! I have passed your Guru advise along to your frined at NOV...(he has a new 2003 BMW...that was the advise right??Tp

max said...

Right, I guess you could interpret it that way? Not! Maybe our friend should reread his study notes in this class. Or, I guess he can learn the hard way like the rest of us. So what is so wrong with working until you are 80?