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Investing 401k and IRA Funds

Partners' Network Blog

Investing 401k, 403b, IRA and other retirement plan funds should be approached differently than for investments in your individual name.  The tax sheltered or tax free accounts are intended to provide cash flow in your retirement and to meet those spending needs.  Because of this, investors need to take a very long view.  Regardless of your age, these accounts are designed to outlive you even with required minimum distributions (RMD) that will start at age 70 ½.

There are many ways of investing and many types of investments.  This blog will discuss the reasoning that I believe should be employed in making the investment decisions for your retirement accounts.  My personal opinions are expressed, but I ask you to think about what I suggest and also consider if what I say seems logical.  If it does, then compare it to what you are doing and consider if any changes or tweaking are in order.

I believe the investments should be aggressive as compared to passive or benign.  Aggressive doesn’t mean risky or not conservative.  I define passive or benign as inattentive and not acting because of an over concern about loss.  For retirement plan investments there needs to be an understanding that you are investing for 30, 40 or 50 years.  Even if you are age 70 and married, this applies because the life expectancy tables indicate that at least one of you will live 27 years.  Someone age 50 is investing for 50 years!  This needs a different strategy than investments in your individual name that need to be flexible to adapt to future circumstances and potential availability for myriad situations such as buying a vacation home or bigger house, starting a business, funding a child’s college education or being able to cover expenses if a job is lost.  The retirement plan investments will remain intact unless there is a disastrous life altering event, and in that absence will be used to provide a never ending cash flow after you stop earning a regular salary. The mindset needs to adapt to this long range “forever” situation.

Another thing to consider is that the amount of the portfolio is not as important as its cash flow.  During retirement you live off of or spend cash flow, not assets.  Of course, if you have not accumulated sufficient assets to provide the needed cash flow, then assets will need to be liquidated, i.e. sold, to meet your needs and that will hasten the decline of the portfolio and if the selloff starts too early it could lead to an extinguishment of your nest egg and a halting of your cash flow sometime before your death, which no matter who you are, is a terrible situation to find yourself in.  Of course there are ways to avert this, but that is not what this blog is about, so I’ll pass on it for now.

There are two broad investment categories you can choose from – stocks and fixed income.  When I said aggressive above I meant that a large portion of the investments should be in stocks.  The methods of investing in fixed income are probably much more complicated than buying stocks.  If you’ve been a regular reader of my blogs you will be clear about how I feel about this.  However, irrespective of the complications, fixed income investing will not provide any growth albeit a steady cash flow which at best would only be a couple of percent greater than normal inflation.  However, older people (which you will be when you start your retirement or RMD) usually will have greater individual inflation rates because health care costs seem to grow at higher rates while also becoming a larger percentage of total spending, and it is also not a slam dunk that you will have adequate cash flow as a result of fixed income investing and possibly a greatly changing economy.  Note that if you start early enough, the interest would accumulate and be added to principal thereby increasing the base that will provide the cash flow. On the other hand, if you don’t start early enough, this will not occur. BTW, a 40 or 50 year old with a large part of their retirement funds in fixed income seems to me to be a serious loss of a grand opportunity.

Investing in individual stocks, specific sectors or hot fads can be extremely risky and should be avoided.  What I suggest is to adopt a conservative approach to investing in the stock market and that is to choose from the three or four largest American company index or exchange traded funds.  Doing this wisely will produce a steady dividend of about 1.7% plus increases in the portfolio as the companies in the indexes grow over time.  The dividend yields will remain pretty steady but the dividend dollars will grow as the stock values grow.  To quantify a “break even” growth in the stock values compared to bonds, a growth in stock prices of 3% per year when added to the 1.7% dividend, should be equal to any interest payments you can reasonably expect.  The 3% growth means that the stock index portfolio would double in 24 years.  This 3% rate is much less than any 24 consecutive period since they started keeping track of this in 1926.  BTW the indexes I am referring to are the S&P 500 index, Dow Jones Industrial Average, Nasdaq 100 and Russell 2000.  If you consult with an investment advisor they can help you in your selections.

If you are still working, the investment fund will continually be added to.  If not working, then your portfolio should be in an accumulation phase if you are not yet taking withdrawals.  If you are taking withdrawals or your RMD this would reduce your investments to the extent your portfolio’s annual income is less than the withdrawal amounts.  Just because I used the word aggressive doesn’t mean you need to take excessive risk, but you need to be proactive in constructing the portfolio so that it can have reasonable growth as well as provide current yield or cash flow.

Investing in the stock market will be subject to wide swings in the values including reactions to the economy, jobs, inflation, interest rates and/or political activities and utterances, however, the long term trend should be up as long as you have a well-diversified portfolio of shares in United States listed companies.  My use of the word “aggressive” refers to an overweighting of stocks with a minimum of 75% of your investment portfolio.  Bank certificates of deposit won’t do it for you – you will need longer term bonds.  If you end up with bond mutual or index funds you will be subject to wide swings in the values of these “fixed income” investments subjecting you to the vagaries of the interest rate market without the true benefits of the continuing upside of portfolio growth.

A conclusion that can be drawn from this blog is to consider putting a large percentage of your retirement funds in plain vanilla index or exchange traded funds.  Think about it. Speak with your investment advisor and ask them to show you where I am off base.  And then think about what he or she says and compare it to what I wrote above.

This blog turned out longer than I would have liked it to be, but I believe it states my views carefully and clearly.  Good luck!  Be deliberate!  Your future financial security depends on it!

Do not hesitate to contact me with any business or financial questions at emendlowitz@withum.com or fill out the form below.

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