We are constantly amazed at how many of the folks who give investment advice make it needlessly complicated. That also goes for the financial magazines with front-page headlines: “The Best Mutual Funds to Invest in Now!” The answer is: “Duh! The Mutual Funds You Are Already Investing in.”
Bottom line: You don’t need to pay a financial planner or a magazine for ongoing advice. What follows are eight basic rules of investing. They all boil down to: stick with stocks, don’t time the market, buy and hold and keep your costs low with index funds.
Myth 1: 401(k) Plans are Risky and Scary and We Should Go Back to the Old-Fashioned Defined Benefit Plans.
Fact. I’ll take `money in my pocket’ over `promises that can’t be kept’ any day. First, a little history: the old-fashioned DB plans took off after World War II when America was a “fortress economy”—everything Americans bought Americans made—so pensions were a “carrot” to lure workers. Now we’re part of a global economy in which U.S. companies are under competitive pressure and companies are constantly going in and out of business. Why does this matter to you? You will very likely work for eight to 10 employers during your entire career. You are much better of with a 401(k) account, in which you can “take your vested balance” with you when you change jobs than working for a company with an old fashioned plan that ultimately goes belly up and you may get little or none of your promised savings.
Myth 2: If I change jobs I should roll my contributions over to the new employer plan.
Fact: That’s almost a good idea—it’s definitely a better idea than “cashing out” because you’ll owe taxes and penalties—but a better idea would be to roll the money over to an IRA that you set up with an investment company. (Remember, these rollover IRAs are different than the individual IRAs that have annual contribution limits.) If the average American has eight to 10 jobs during a lifetime the last thing you need is the stress of keeping track of old balances. That’s especially challenging if the company goes out of business or gets acquired by another company. We even have the radical idea that college graduates should set up a rollover account once they start their first job.
Myth 3: I can time the market in my 401(k) brokerage account.
Fact: Not even Warren Buffett knows where the market is heading and if he did he wouldn’t care. If you make the mistake of being out of the stock market during an upswing you could miss out on double-digit investment returns. For example, if you had merely missed the forty best days of the 10-year bull market that ended in February 2002 you would have actually lost money. What happens is that investors tend to sell in a market downturn because some in the financial community and the media tell them to. The result is they get back in the market when stock prices are higher—and wind up paying more for shares than if they had “bought and held” and watch their shares increase in value.
Myth 4: I need to “rebalance” my investments when the market turns.
Fact: Your exposure to stocks should only change when you get older, because you have a shorter time horizon. The thinking behind rebalancing and asset allocation is that it helps you avoid volatility. What you want to avoid is loss and as long as you have a buy-and-hold strategy with your stock investments you will do fine over 30-40-year time periods. Volatility is less a function of the markets as it is a measure of ignorance and/or chicanery—i.e., selling stocks in a downturn, brokers “pump and dumping” shares of lousy IPOs, corporate bad guys massaging earnings, etc.
Myth 5: If I have low “risk tolerance” I should avoid stocks.
Fact: See previous myth: If you are in your 20s and 30s and you DON’T invest in stocks you will not save enough for retirement—period. You should stay fully invested in stocks until you’re in your 50s or so. We’re working on an exact formula on when people should shift into cash-equivalents like money market funds and we’ll keep you posted.
Myth 6: I need to replace 70% of my pre-retirement income when I retire.
Fact: Even if this phrase is true, what the hell does it mean—replace it for how long? A better formula would be what is the multiple of “final pay” you need to accumulate to last your life expectancy; right now our theory is that it’s “10 times final pay” (the salary you expect to earn right before retirement.) We’re working on it and we’ll keep you posted.
Myth 7: The annual limits on 401(k) contributions reflect how much I should sock away.
Fact: The annual ceiling on tax-favored contributions is not a savings formula but a strategy by Congress to maximize tax revenue. Most 401(k) investors who have waited until their mid 40s to save—which is most of us—will have to contribute outside of their plan to stay on target. If, for example, you're 45 years old, you earn $76,689 a year, and you haven't contributed a dime to a 401(k) plan, you would have to contribute about $19,000 a year to attain a $1.6 million nest egg. Even more preposterous is the measly limit in “catch-up” contributions for people over 50.
Myth 8: But wait! Didn’t a law pass that makes 401(k) investment advice legal? Won’t that help?
Fact: This law has to do with what investments to pick, which matters way less than what percentage of salary folks should be saving in their accounts—depending on their age and current savings—to achieve a comfortable nest egg. For the most part, this communication is not taking place for 401(k) participants. We’re working on it and will keep you posted.