Business First

Saving Race
When it comes to retirement investments, starting early can get you to the finish line
by Bonnie Van Ness, Ph.D.

As an Ole Miss alumnus, you’ve already made an important investment in your future—your education at Ole Miss. However, retirement looms, and perhaps you’d like a weekend home in Oxford. These financial goals take planning or generous wealthy family members—or maybe both. There are a few steps you can take that will bring you closer to your financial goals.

The first will come as no surprise: save. Equally important is to save early. Although retirement may seem a long way away, you will not have to invest as much to meet your financial goals if you begin the process early. Starting to save early may be even more important in the future. Some recent projections for general stock market returns have been in the neighborhood of 7 percent to 8 percent per year, rather than the historical 12 percent to 13 percent seen since the 1920s.

Let’s say that you graduate at age 23 and plan to retire at age 65 with $3 million. Given historical stock returns, you’ll need to invest in the neighborhood of $2,000-$3,000 per year to reach your goal. If you procrastinate and begin saving with only 20 years until retirement, then you’ll need closer to $37,000 to $42,000 per year. If market rates drop, then starting at age 23, you’ll need to invest $10,000 to $13,000 per year to have the same $3 million. It will take a whopping $65,000 to $73,000 per year if you wait until 20 years before retirement!

Frequently, there’s not much left over after paying for all the things that you want and need to do. That’s why most financial planners advise you to pay yourself first—not last. Then try not to borrow from your savings. Although there may be times when borrowing from your retirement is warranted, a new car (when the old one works fine) is not one of them.

Proper asset allocation also is important in meeting your financial goals. Asset allocation deals with the mix of assets in your portfolio. The appropriate mix of risky to less risky assets will depend, for one, on your point in life. The younger you are (or the further away you are from your financial needs), the more risk you can take. On the other hand, if you’re only a few years from retiring (or your child is on her way to Harvard next year), then you shouldn’t have all your accumulated wealth in risky investments.

Using the earlier example, if overall stock market returns are 7 percent to 8 percent, then, assume bond returns would be 3 percent to 4 percent. If, upon graduating, you were able to invest $10,000 per year and chose to put the money in bonds rather than stocks, then upon retirement you would have only $820,000 to $1,050,000—not even close to the $3 million that you might get with the stock fund.

On the other hand, it’s Sept. 1, 2001, your child will graduate from high school in May and then start his college career. You have saved $100,000 for college expenses and the money is in a fund that mimics the S&P 500. On Sept. 21, your child’s $100,000 college fund is now worth only $85,060. Sure, the events of Sept. 11 were extreme, but other less dramatic events happen reasonably often that cause stock market investors to revalue their holdings.

Another factor that should not be overlooked is risk tolerance. While some people are happy pouring their entire wealth into technology stocks, others worry so much about their investments that they simply cannot sleep at night. While investing more of your wealth in reasonably risky assets may put you closer to your financial goals, if it means you’re going to suffer from multiple stress-induced illnesses, then the boost in earnings from the riskier assets is probably not worth it.

OK, now you know to save, to save early in your career, and to gear your investments to your point in life and individual risk tolerance. So where should you invest your money? Unfortunately, there is no magic answer to that question. If you enjoy researching financial issues and feel comfortable with your ability to devise and execute a plan for your financial future, then you’re well on your way. If not, then it’s probably advisable to team with a financial adviser who understands your financial situation and knows your goals as well as your risk tolerance. Most importantly, find a financial adviser whom you trust—but don’t trust blindly. And realize that financial advice does not normally come free. Even if you are not paying an explicit fee for the service, you may be paying indirectly via commissions or loads charged by some mutual funds. Finally, monitor your portfolio performance, stay abreast of economic and financial news, and ask questions.

There are so many investment vehicles available today—stocks, bonds and mutual funds, just to name a few. Further aiding your search (or compounding your confusion) is the amount of financial information available via the Internet. It may seem like a full-time job just keeping up with the news affecting your investments.

What about investing in the “hot stock-of-the-day?” Generally, the answer is, “Don’t.” Here are a few of reasons why:

•		By the time most of us learn about this “hot stock,” the fact that it’s a hot stock has probably been priced in, meaning that it’s no longer a bargain. And by the time we learn that it’s now the market dog—that fact will already be priced in as well. Leave market timing to the professionals (even they have difficulty with it).
•		Chasing hot stocks—turning over your portfolio funds—costs money, which lowers your return. Truly staying up with the breaking news on a well-diversified portfolio can be a full-time job. Not only will constant buying and selling cost you money in transactions costs, it will cost you many hours—and time is money. Does that mean you should buy a stock and “stay the course,” never revisiting the decision? Certainly not. However, buying good stocks for the long run and periodically re-evaluating the contribution of that stock to your portfolio will probably give you the most value.
•		It’s dangerous to cash in your portfolio and put the money in one stock. Don’t give in to the temptation of turning a quick profit.

So, what should you do? If, after researching the company, you think it is a good addition to your portfolio, then invest a portion of your portfolio in it (most professionals advise no more than 10 percent of your portfolio in any one individual stock).

Let’s say that you don’t have enough time to fully research 10 stock purchases and keep up with the news on them. Or perhaps you don’t have sufficient money to diversify. Or perhaps you have sufficient money, but you don’t want to make individual stock choices. There are still plenty of investment vehicles for you.

Mutual funds abound, and there’s probably at least one that lines up with your interests. Some funds offer “instant diversification,” and some funds invest only in particular sectors, such as precious metals. One caution regarding mutual funds: Check the loads and the fees. These can significantly lower your return.

Other investment vehicles called exchange traded funds (ETFs) are good for investors who want to earn “market” returns. While many ETFs exist, some of the most commonly recognized are spiders, diamonds and cubes (SPY, DIA and QQQ, respectively). The spiders track the S&P 500 index, the diamonds track the Dow Jones Industrial Average, and the cubes track the NASDAQ 100 index. These funds trade on the major exchanges, track indexes that most of us are familiar with and have very small administrative costs.