Hugh Wynn's Two Cents

While I'm not an investor by profession, I have been curating sound personal financial habits and practicing those techniques since I was a youngster. Although the focus of this blog is on our three youngest generations, I will ceaselessly emphasize to all investors the importance of an early and routine savings habit, a common sense buy-and-hold strategy, a diversified investment portfolio, the wisdom of shunning market timing, and a “stick to your guns” attitude regardless of negative outside influences. I believe it is imperative that you keep your investment strategy simple and your investment costs as low as possible. Like the small investor’s best friend, Jack Bogle, was quick to remind us, “In the fund business, you get what you don’t pay for.”

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past Posts

What Are Target-Date Funds?
March 19, 2020
Target-date funds (TDFs) are offered to investors that seek to grow assets over a specified period of time, usually for retirement.
read more
See a Penny...
March 12, 2020
You’ve heard the old refrain, “Watch the pennies and the dollars will take care of themselves”. It’s the underpinnings of everything I have to say about saving and investing.
READ MORE
Potential Tax Cuts in 2021
March 5, 2020
During this endless political season – I’m fine with about six months of campaigning instead of two years – there have been some behind-the-scenes mutterings about how to address America’s extremely low non-retirement household savings.
read more
Win Your Own Lottery
February 27, 2020
How often do you play the lottery? It’s not uncommon for routine lotto participants to spend $1,000 or so per year chasing this “get-rich-quick” gambit.
READ MORE
The Mythical Millionaire
February 20, 2020
A couple of subscribers I’ve chatted with recently seem to think that if they retire with a million bucks in their retirement account, they’ll be in hog heaven. No doubt, it’s a very comforting figure. But should it be?
READ MORE
Target-Date Funds: Simple, Diverse and Great for the Autopilot Investor
March 19, 2020

If not by now, you will soon be fully aware of my devotion to the simplicity of index fund investment portfolios. Many of my examples focus on the “early-in-life” saving for retirement by investing in a single index fund to achieve a modicum of financial comfort thirty… 40… 50 years hence. But, of course, there are more ways than one to skin a cat, while maintaining an allegiance to those PDQ Principles I mention so frequently. Let’s consider another increasingly popular approach.

Target-Date Funds

Target-date funds (TDFs) are offered to investors that seek to grow assets over a specified period of time, usually for retirement. Often named for the year in which an individual plans to retire, the fund’s asset allocation becomes a function of the time available to meet the investment objective.

The notion behind TGFs is something that, not surprisingly, has a great deal of appeal to me – their simplicity and diversity. Generally speaking, most of us accept the idea that stocks are riskier than bonds; that as we grow older, it makes sense to reduce market risk by holding more bonds in our investment portfolio than stock; and that rebalancing a portfolio to properly weight the stock/bond ratio makes sense along the way. Therein lies the appeal of TGFs. By design they radically adjust to a less risky (more conservative) investment mix as the so-called “target date” of an investor’s retirement looms.

This simplicity makes TDFs increasingly popular vehicles for 401(k) plans – and attractive to investors prone to putting their investing activities on autopilot. Particularly when the fund’s portfolio is allocated to various index funds.  Take the case of a young man hoping to retire in 2065. He would likely choose a more aggressive target-date 2065 fund. An older individual nearing retirement (say in 2025) might choose a more conservative target-date 2025 fund. My fund company of choice, Vanguard, offers a comprehensive series of target-date funds¹, using several index funds as underlying securities for the investment. Let’s compare a couple of their funds to illustrate those target-date characteristics:

Vanguard Target Retirement 2065 Fund (VLXVX)

The Vanguard Target Retirement 2065 Fund (formed 7/12/2017) has a low-cost annual operating expense ratio of 0.15%. The Fund’s portfolio percentage allocation as of January 31, 2020, stood at 54.2% of assets invested in VG: Total Stock Market Index Fund, 35.6%  in VG: Total International Stock Index Fund, 7.1% in VG: Total Bond Market II Index Fun, and 3.1% in VG: Total International Bond Index Fund. In short, a more aggressive 90% in equities and a conservative 10% in bonds and cash equivalents because of its long-term horizon.

Vanguard Target Retirement 2025 Fund (VTTVX)

The Vanguard Target Retirement 2025 Fund (10/27/2003) has a low expense ratio of 0.13%. The fund’s portfolio percentage allocation as of January 31, 2019, stood at 36.2% invested in VG: Total Stock Market Index Fund, 23.5% in VG: Total International Stock Index Fund, 28.4% in  VG: Total Bond Market II Index Fund, and 11.9% in VG: Total International Bond Index Fund. This is a less volatile, shorter-term mixture of 60% in equities and a more conservative 40% in bonds and cash equivalents.

Beyond the target date¹ – for folks already in retirement – the Vanguard Target Retirement Income Fund (VTINX) gravitates to an even more conservative, less volatile asset allocation (roughly 18% in domestic equities, 12% in international equities, 37% in domestic bonds, 16% in international bonds, and approximately 17% in short-term TIPS (Treasury Inflation Protected Securities). Its annual expense ratio is a very low .12%. Although I used Vanguard funds in my hypothetical example, a wide variety of marketplace target-date options await the investor – funds with various asset allocation strategies to fit differing risk and management preferences.

Nothing Is Foolproof

The Great Recession of 2008-09 reminded many investors that even for folks close to retirement, TDF’s have their own shortcomings. With all of the talk of their conservative mix of highly diversified investments as retirement nears, they still hold a certain percentage of investments in stock, and they do take a one-size-fits-all approach to investing. In short, the funds simply can’t consider each individual investor’s unique portfolio needs. And the automatic approach to investing strategy simply ignores changing market conditions. Therefore, it’s important that investors consider the caveats of  their risk profile when considering TDFs, including the cost and performance of a particular company’s TDF portfolio. It’s always essential to compare fees, and it goes without saying that any conscientious investor should continue to pay attention to changing market conditions. No approach to investing should relieve us of that duty.

For inexperienced investors dealing with an array of confusing choices offered by their employer’s 401(k) program, TDFs can be a relatively low risk starting point in the saving and investment cycle. But there are no panaceas out there. As conditions change in one’s financial life, the types of investment suitable to those changed circumstances might also change.

Coronavirus: Lessons Learned?

According to Morningstar Direct, in 2008, target-date fund portfolios for folks planning to retire in 2010 took a nose-dive of 36% from the market’s October 9, 2007 peak, on average, during the Great Recession (the broad index fell 55% during that crisis). Compared to the current coronavirus scare, from the February 20, 2020 market high through last Thursday, TDF portfolios of folks who planned to retire in 2020 dropped by about 13%, on average. During the Great Recession, the 36% loss by near-retirees in TDFs represented more than two-thirds of the 53% decline suffered by those planning to retire in 30 years. By comparison, losses by today’s investors close to retirement represent about half of the 24% market decline.

Hopefully, lessons were learned from the bitter Great Recession experience. We’ll soon find out.  

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¹Vanguard Target Retirement Funds offer a diversified portfolio within a single fund that adjusts its underlying asset mix over time. The funds provide broad diversification while incrementally decreasing exposure to stocks and increasing exposure to bonds as each fund’s target retirement date approaches. The funds continue to adjust for approximately seven years after that date until their allocations match that of the Target Retirement Income Fund (Source: Vanguard).

Watch Those Pennies. The Dollars Will Take Care of Themselves.
March 12, 2020

I practice this philosophy every day… obsessively, according to my Gen-X daughters. It’s the underpinnings of everything I have to say about saving and investing. Face it, if you don’t save, you have nothing to invest – unless you’re a debt-leveraging dude. And a critical ingredient of saving is watching those pennies…every single one. Recently, while wandering around Lowe’s tool department, I spotted a penny on the floor. Out of sheer habit, I bent over, picked it up, and stuck it in my pocket. Was it worth the effort? No, but the ingrained habit of watching those pennies is what’s important. (Watch the video below.)

A Penny's Worth

Watching your pennies is a very important factor in making quality investment decisions. In fact, it is crucial to optimizing return on investment. Focus for a moment on the simple act of deciding which of three investments to make. Mutual fund companies charge an “annual operating expense ratio” for managing money in their funds (there are no free lunches, but Vanguard’s John Bogle certainly made the Wazoo crowd more honest than it was prior to the mid-1970s).

Let’s assume that you’re investigating a possible $10,000 investment in three funds of relatively equal quality: 1) a Total Stock Market Index fund that charges an expense ratio of 0.04%; 2) a fund that charges 0.25%; and 3) a third that charges 0.90%.

How does your final choice impact the value of your retirement portfolio 40 years hence, given a theoretical market yield of 7% on each, compounded annually? Per the results in the table, with the first fund, you accumulate approximately $147,400 of value, in the second case $135,500, and in the third case $104,300.

True Cost of Tiny Fees  

The significant variable in our example is the annual operating expense ratio. In short, a fraction of a single percent (i.e., the .86% difference in Case One and Case Three) could ultimately reduce the value of your retirement portfolio by  as much as $43,000 after 40 years on a relatively small initial investment of $10,000. SO, WATCH THOSE PENNIES! Make this mistake enough times while waltzing toward retirement and dog food might be in your future. (By the way, the $43,000 difference is comprised of $14,200 in additional fees and $28,800 in opportunity cost associated with paying those additional fees.) That’s the money the late John Bogle spoke of when he said, “You get what you don’t pay for.”

It's All Hypothetical

The scenario I paint above is, of course, hypothetical. Future investment rates of return aren’t predictable with any certainty. Investments that yield higher rates are generally subject to higher risk and volatility. Rates of return vary widely over time, especially for long-term investments, including the potential loss of principal. However, paying a higher annual operating expense has little to do with market risk and more to do with watching your pennies. And if you don’t avoid those tiny fee differentials (i.e., watch those pennies), the down-the-road impact on your lifestyle in retirement can be significant.

A Note: The Coronavirus On Steroids

With dizzying speed, the Coronavirus has moved the market index from its recent all-time high to bear market territory in just 19 sessions! Amazing. In previous downturns, it has taken the index, on average, 136 trading days to enter bear market status from its most recent high (Source: Dow Jones Market Data). The combination of this new virus and the ridiculous Saudi/Russian kerfuffle regarding crude oil production has been particularly unsettling to investors.

This, too, shall pass, folks. Just keep the faith.

The Skinny on Non-Retirement Household Savings Accounts
March 5, 2020

During this endless political season – I’m fine with about six months of campaigning instead of two years – there have been some behind-the-scenes mutterings about how to address America’s extremely low non-retirement household savings. A solution to this dilemma, partial or otherwise, might help stem the ballooning dependence of many of our citizens on so-called government entitlements. Could such a solution be accomplished through the tax code without feathering the nest of those big birds in the upper branches of our national tree? Perhaps. In addition to encouraging non-retirement household savings, such a program might also address the income disparity between those upper branch big birds and the many smaller birds in the middle and lower branches.

Rainy Days, Indeed

According to a 2018 Federal Reserve study, the average American family has less than $11,000 in non-retirement household savings… few readily available financial resources to deal with an emergency. Why? Do they lack the ability... the motivation... the whatever… to create a “rainy day” fund? Yeah, I know, I blogged about rainy day funds back in July 2019, so let’s not cover old ground. But I would like to discuss one idea that is making the rounds among Trump economic advisers should his administration serve a second term.

What’s The Plan?

Who might be the target of these non-retirement household savings accounts? Perhaps those American families who occupy the lower- and middle-income branches earning as much as $200,000 a year. How’s that for attempting to reduce the usual clamor of “tax cuts for the millionayes and billionayes”? So, how is this proposition different from existing retirement plans, you ask? It has some similarities and some distinct differences. The non-retirement household savings account would allow eligible families to sock away up to $10,000 per year pre-tax in a savings fund. A popular suggestion is that the money be invested in low-cost stock index funds, which would minimize risk through diversification. Sound familiar? These features would expand ownership of stock to all participants, allowing millions more folks to share in future stock market gains. These features would not only help reduce the wealth inequality between the big and small birds, they would also enable many more of the smaller birds to enjoy The Amazing Power of Compounding.

What's The Difference?

This non-retirement household savings account would, of course, be voluntary in nature and employers would be encouraged to match employee contributions. After an accumulation period of five years, funds in the plan could be used for virtually any purpose: to supplement income in the event of job loss; for all emergencies; to buy or improve homes; to start a new business; to send kids to college and/or to private or tech schools; and yes, even for retirement. In short, this type of plan is not meant to be restrictive of use; rather, it’s purpose is to encourage non-retirement household savings.

“Too Familiar” Tax Feature

There would be one very familiar feature. It’s well-known that Uncle Grabby (IRS) gets grumpy when he loses revenue. As with distributions from pre-tax contribution retirement accounts, Grabby would recapture tax revenue delayed by contributions to these household funds when the money is finally withdrawn and spent. In short, and as usual, Grabby would get his pound of flesh by taxing those pre-tax contributions – and the dividends and capital gains they earn – when the money is finally withdrawn. But withdrawal is not a requirement.

In Summary

These tax-affected non-retirement household savings could well be a major step toward replacing the entitlement culture with incentives to save for broad-based wealth creation – I call ‘em fat and sassy, tax-advantaged rainy day funds. And they would certainly be better than another proposition being circulated by certain “Deep State” forces – a plan to eliminate the existing pre-tax contributions to retirement plans and go “all in” on Roth-type plans. In short, under this troubling proposition, all monies contributed to retirement plans would be after-tax dollars. No pre-tax dollars allowed. I’m a firm believer in Roth plans, but it’s sure nice to have the choice of paying taxes now or paying them later.

A Virus Note

Since 1994, 10 major health issues – Zika, SARS, avian flu, etc. – have significantly impacted global markets. In eight of those cases, stocks climbed more than 10% after 12 months once investors properly evaluated the threat. Since 1946, there have been 26 market corrections of at least 13%. On average, it has taken about four months to recover to pre-correction levels¹. Panic if you must, but patience might serve you best. Just remember, big market declines are unsettling. Usually they’re linked to some totally unexpected global event – a time, perhaps, to re-assess your “true” risk tolerance. If you’re very uncomfortable with today’s events, you might want to consider a different asset allocation once the market recovers…and it will. We just don’t know when.

¹Source: Adena Friedman, President and CEO of Nasdaq, Inc.
Winning Your Own Lottery
February 27, 2020

How often do you play the lottery? It’s not uncommon for routine lotto participants to spend $1,000 or so per year chasing this “get-rich-quick” gambit. Buy a ticket and win $100, a $1000, perhaps $1,000,000+ against overwhelming odds. Recall the incredible $1.537 billion drawing won by a single South Carolinian. The odds of winning that prize exceeded 1:302,000,000, roughly the same odds as one citizen in the United States (population 333,000,000+) being selected in a drawing to win the big prize. It happened, but it wasn’t you… or me… or all the other 333,000,000+ Americans. Watch the video below.

Improve Your Odds

How about reducing your odds from 1:302,000,000+ to a more believable 1:1 depending on how patient you are over the next 45 years? Here’s the deal. For those of you in the early stages of a career (say 22 years of age), instead of buying $100/month of lottery tickets, contribute an initial $3,000 (the initial minimum contribution in after-tax dollars) to a Roth IRA and deposit the $100/month (again, after-tax dollars) of “lottery savings” into the Roth for 45 years. Invest every penny of it in Vanguard’s Total Stock Market Index Fund, Admiral shares, compounded quarterly (which has earned a return on investment (ROI) of 7.14% since its 2000 inception – and Voila! you wake up on retirement morning with a $466,000 balance in your Roth account. This is in addition to Social Security, your work-related 401(k) or 403(b), your home, and all the other assets and retirement savings you’ve accumulated during that same period.

Because folks purchase lottery tickets with after-tax dollars, I assumed a $3,000 initial investment (the required minimum) and the $100 monthly contributions would fund a Roth IRA. In retirement, Roth IRA withdrawals are tax-free. The VG Index Fund’s 7.14% ROI is based on the fund’s returns since its 2000 inception. I made no inflation adjustments. By the way, the Total Stock Market Index Fund has earned, on average, 13.82% over the last 10 years, so  using 7.14% in my hypothetical example doesn’t seem overly optimistic… but who knows?

Food For Thought

Okay, so it doesn’t sound like much compared to $1.537 billion, but think about that $466,000 every time you walk into a convenience store during the next 45 years and throw down a few loose “after-tax” dollars for a lottery ticket. I’ll take the 1:1 chance of ending up with $466,000 upon retirement versus those long odds of being extremely lucky. But remember, to gain these improved odds, you have to be very disciplined… and very patient.

A Bird In Hand

Speaking of the lotto, a quizzical subscriber asked me the following question: If you became a lucky winner and had the choice of taking $50,000 today or $80,000 spread evenly over 30 years, what would you do? And how would you invest the money in either case? In responding to these questions, I assumed that in both cases the money was invested in taxable accounts to avoid muddying the water about who might be eligible to place those winnings in retirement fund vehicles.

As usual, in both cases, my investment choice would be the aforementioned index fund. As to the cash,  I would invest the lump sum assuming an annual return of 7.14%, compounded quarterly, which mathematically would grow to $418,000 before taxes and inflation after 30 years. In the second case, I would invest the larger sum evenly over 30 years (assuming the same yield of 7.14%, compounded quarterly), which mathematically would grow to approximately $312,000. Granted, my approach is very simplistic, but it certainly reaffirms the value of “a bird in hand” even when it’s a smaller bird².

Save A “Real” Million Bucks By Retirement
February 20, 2020

A couple of subscribers I’ve chatted with recently seem to think that if they retire with a million bucks in their retirement account, they’ll be in hog heaven. No doubt, it’s a very comforting figure. But should it be?  I ran a hypothetical calculation for myself assuming I was 28 years of age. Hey, don’t giggle, I’m only about twice that age (if you’ll permit me to use the term “about twice” quite loosely).  I simply want to present an example that at age 28, with a good job, and already having saved $10,000, how much more money would have to be tucked away monthly, invested at 7%, compounded annually, to achieve millionaire status at age 68 (40 years hence).  

More Than Meets the Eye

I grabbed my abacas (Source: Bankrate’s Investing & CD Calculator - Save a Million Dollars Calculator), slapped around a few beads, and Voila! I had my answer. In addition to the $10,000 seed money, I’ll need to invest another $343 per month to reach that million-dollar goal. Seems doable – particularly if I have a generous employer who matches some of my contributions. And there should be nice raises in this mythical future even as my family grows and requires a bigger house, dependable cars and college or trade school educations.

But then I realized that there is more to the calculation than first meets the eye. I forgot to allow for Izzy The Inflation Monster! So, I threw in a 2.5% per year inflation factor to feed that hungry beast who will gobble up as much of my purchasing power as it can during those intervening 40 years.

The Inflation Monster

Using that 2.5% inflation factor, here are the numbers. Beginning with the $10,000 initial investment and adding $343 each month for 40 years, I do end up with roughly $1 million in my retirement account at age 68. Unfortunately, those “gray bearded” million bucks will only purchase $373,300 worth of goods in today’s dollars.

So, I go back to the abacas and bean-count how much more I must save to end up with $1 million in purchasing power at age 68. And boy is that a Zebra of a different stripe! To have $1 million in today’s purchasing power 40 years hence, I will need almost $2.7 million in my retirement account, not just $1 million.

What the...???

To achieve this new goal, it will require a monthly savings of… gasp… $1,020 instead of the $343 I mentioned earlier. But being a “glass-half-full” chap, I desperately try to see the silver lining of this cloudy dilemma. By saving at the $1,020 clip per month, I’ll have about a million bucks sitting in my retirement account by age 55 – a “fat-cat” millionaire 13 years ahead of the original schedule… for whatever that’s worth.

Still, take heart in the fact that although inflation steals an individual’s purchasing power, it also tends to exert upward pressure on paychecks. In short, the higher $1,000 per month savings requirement might be more achievable than one might imagine. Inflation tends to lift all boats… income as well as expenses.

Clear as Mud

But don’t forget, this scenario is hypothetical. Future rates of return aren’t predictable with any certainty (they can vary widely over time, especially for long-term investments like I assumed here). Investments that pay higher rates of return invariably come with higher degrees of risks and more volatility. And to really brighten your day, the loss of investment principal is also a possibility. So, immerse yourself in a bowl of Blue Bell® ice cream and hope that the (also mythical) Social Security trust fund (like so much of the other money we send to politicians) doesn’t soon disappear into that fetid, alligator-infested, Washington D. C. swamp – and for goodness sake, start saving!

By the way, there’s stirrings among political investment advisers about tax-free investment accounts for lower and middle-income families – and they’re not retirement accounts. These accounts would accumulate funds that, after five years, could be used to buy or improve homes, start new businesses, send kids to college or private schools, supplement income after job loss, or yes, even for retirement. It’s an interesting idea. We’ll talk more about it in a week or so.