Retirement Plan

What criteria should one identify when selecting investments within a 401(k) at work?

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  1. Mike Finley says:

    What asset class or classes do you want to own and what do they cost? That is the simple answer, but as usual, there is more to the story. The asset class? Stocks (equities), bonds (fixed income), Real estate (REITs), and cash (Money Market) are the big four. Cost? What is the expense ratio (the fee that goes to the mutual fund company and possibly others) on each mutual fund you are considering?

    Here are a few basics. Focus on owning a total stock index fund that owns the entire U.S. market when possible. Add in an international index fund when it works. Finally, consider a bond index fund and a REIT index fund AS YOU CONSIDER ANY OTHER INVESTMENTS YOU OWN OUTSIDE YOUR COMPANY RETIREMENT PLAN. The index funds will keep your costs as low as possible whether you have a good plan or not.

    What is not important? The past returns on those funds and the star ratings mean absolutely nothing. Just ignore that noise. This means NOT chasing past performance. It gives you no information on what fund to select and that is important to know. Focus your efforts on owning broad market funds (hopefully index funds are offered, if not, contact HR and demand it) that own stocks and bonds in the right mix that fits your time horizon, risk tolerance and goals.

    Feed those accounts (strive to go heavy on stocks through much of your working life when possible for maximum growth over time) as much as you can month after month and year after year as you watch the amazing thing of compound interest do its magic. Learn more on this subject by reading What Color is the Sky. Education followed by action will set you free. Believe in that and believe in YOU.

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Experts

Why is it so important to educate yourself on financial matters from independent sources?

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  1. Mike Finley says:

    Most people who “help” you usually have a conflict of interest with the information they are sharing. The local life insurance agent makes his money through commissions, trailer fees, bonuses, etc. and so, he ends up recommending high cost annuities and whole life policies because they make him the most money. Good for him, not for you!

    The local fee-based financial advisor gets his money through loads, commissions, trailer fees, kickbacks, bonuses, etc. and so, they also must be avoided as they “recommend” the best funds for your needs. The conflicts of interest hurt the average investor as the advisor ends up working for the people who pay him “behind the scenes.”

    The third group is a hodge podge of charlatans, clowns who have strong opinions, and others who spout off with little to no evidence to support their positions. This means shutting off the television in most cases and not listening to Fred in the break room or Uncle Joe at the dinner table. You must look elsewhere when learning about the world of money.

    The key is in finding those independent experts who truly know what they are talking about and are not earning money outside of what you pay them. Here are some of those experts: Jane Bryant Quinn, Eric Tyson, Jason Zweig and Jonathan Clements when it comes to the world of money.

    When learning about the world of investing, go here: John Bogle, William Bernstein, Burton Malkiel, Charles Ellis, Larry Swedroe, Rick Ferri, David Swensen, and a guy by the name of Warren Buffett. Wisdom will follow as you start to see the truth amongst the noise and outright lies. The path is clear. Identify it and get on it as you take action with what you learn. Financial freedom to follow!

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Vesting

What is Vesting in regards to your retirement account and why do you need to know it?

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  1. Mike Finley says:

    Vesting deals with ownership of matching money provided by the business. Your vesting period will run from 3 to 5 years in many cases based on where you work and how the employer has set up the plan. This means that you need to work at that location for a set period of years to be fully vested in the plan. Vested means you become the owner of the matching money instead of the business. This is important!

    The money you put into a retirement plan at work is always yours no matter how long you work there. The matching money becomes yours based on the vesting period and that can be different based on the employer. Some employers provide you a percentage per year (like 20%) rather than an all or nothing approach. You want to fully understand your plan and how your employer does it if matching money is offered.

    Let’s say you have a 5 year vesting period. Many employers will provide you vesting at 20% per year. So after 3 years, 60% of the matching money becomes yours and after 5 years, it all becomes yours. Other employers give you all or nothing based on a set period of years like 5 years. Knowing this information should help a person think carefully before moving on to another opportunity. Get vested!

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Negative Correlated Assets

Why is it critical that you have negative correlated assets in your portfolio?

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  1. Mike Finley says:

    You need negative correlated assets in your portfolio so everything doesn’t go down at the same time. What is negative correlated assets? Assets that go in different directions. Stocks and high quality government and corporate bonds would be one good example.

    These two asset classes tend to go in different directions much of the time (but not all of the time). It is the see saw affect. One is going up and the other is going down. These keeps your portfolio from tanking as one asset class keeps you afloat during the stormy weather.

    There are other negative correlated asset classes, but they are more correlated than stocks and quality bonds in most cases. Here are a few:

    Emerging Market stocks and U.S. stocks.
    REITs (commercial real estate) and large cap U.S. Stocks.
    Small company stocks and large company stocks.
    Developed Market stocks and U.S. stocks.
    Value stocks and growth stocks.
    Short-term bonds and intermediate-term bonds.

    Here is the key when applying this information to your life. Work at owning all of these asset classes in your portfolio over time to reduce the volatility (not eliminate it) and increase your returns. Wealth to follow! Learn more about this issue by reading What Color is the Sky.

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Defined Benefit vs. Defined Contribution

What is the difference between a defined benefit plan vs. a defined contribution plan? Why should you care?

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  1. Mike Finley says:

    A defined benefit plan (pension) has the employer doing most if not all of the work for you in this retirement plan. They put in the money, they take the risk, and one day you get the pot of money that has built up over time. Years past, this was the norm. Gradually, they are being replaced with defined contribution plans.

    A defined contribution plan (401k, 403b, 457, TSP) has the employee putting in most if not all of the money into his or her retirement plan. The responsibility of funding the account and risk has been shifted to the employee. The fund grows in many cases based on the employees efforts and knowledge about investing money.

    You should care because that is your future we are talking about. What you know and what you do will play a big part in how your future retirement needs are met. Educate yourself further by reading What Color is the Sky and Graduation! Financial freedom to follow.

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Investing

Market risk is a scary thing, but there is another risk that does far more harm to your money. What is it and how can you combat it?

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  1. Mike Finley says:

    That risk that does more harm to your money over time than market risk is inflation risk. That “hidden” monster gradually eats your money little by little by little as the cost of goods and services goes up. The way to combat this issue is to garner positive real returns on your money.

    Real return? The nominal rate of return (earning .1% in the bank for example) + the inflation rate = the real return. To stay ahead of that inflation monster, you need to get your money working for you so the returns beat the yearly inflation rate. The best investment to do that over the last 90 years has been stocks and it’s not even close.

    Taking on market risk (the ups and downs of the daily speculative markets) will give you the returns you will need to outpace inflation. Focus on owning low cost no-load index mutual funds and keep feeding those accounts through good times and bad. Wealth to follow!

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Modern Portfolio Theory

What is modern portfolio theory and why is it so important to apply it to your portfolio?

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  1. Mike Finley says:

    Modern portfolio theory deals with the process of taking many asset classes (bonds, stocks, Real estate), some very risky (Emerging Markets), and by placing them in a diversified portfolio, you can actually reduce the risk of the entire portfolio based on the negative correlations one asset class has with another. It is the seesaw affect at play. When one side is going down, another is going up.

    The wise investor applies modern portfolio theory to their investments in a wise and cost efficient way to reduce overall risk and increase returns over time. Ignore the returns of any one asset class (every dog has its day), and instead, focus on the overall return of the portfolio. Do this with low cost index mutual funds and you are well on your way toward becoming the wise and successful investor.

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Negative Correlations

When putting together an investment portfolio, why is negative correlated assets important to own?

One thought on “Negative Correlations”

  1. Mike Finley says:

    You want negative correlated asset classes so everything doesn’t drop all at once within your portfolio. Think of this issue as you would a seesaw from your youth. When one side is going up, the other is going down. The game works only when the two sides work in conjunction with one another.

    For example: Stocks and bonds tend to have a pretty good negative correlation. Often times (not always) when stocks are going up, bonds are going down and vise versa. This is one of the reasons why you want bonds (high quality U.S. government bonds are the ideal negative correlated asset class of bonds) and stocks in your portfolio.

    Negative correlations are not static, which is to say they change in different environments (the variation changes). This is also why we have different size companies (small vs. big) in our portfolio. Owning emerging and developed international stocks is wise as well. International bonds might help and so could stock in commercial Real Estate (REITs).

    The bottom line? It would be wonderful if your portfolio went up everyday, but that is not realistic. You want investments that keep you afloat when others are tanking for one reason or another. You want negative correlated asset classes!

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Credit

What are the top two ways you can improve your credit score?

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  1. Mike Finley says:

    (1) Pay your bills on time. This means getting organized with your finances so you have a clear understanding on when bills come in and when they must be paid. This makes up 35% of your credit score. It is a BIG deal.

    (2) Use a small amount of credit in relation to what is offered to you. Use less than 10% of your available credit and your credit score will go up, up and away. First, identify the credit limits on all credit cards. Let’s say that number is $1,000. If your monthly balance averages $400, you are using 40% of your available credit. That is not good.

    THE FIX: You want to use $100 or less. You can contact your credit card company and request an increase in your limits to change this %. Request a big number like $10,000. Maybe they give you $5,000. With $5,000, a $400 credit card balance is well under 10%. This makes up 30% of your credit score. Winner, winner, chicken dinner!

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Opportunity Cost

What is opportunity cost and why is it so important to your financial life?

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  1. Mike Finley says:

    Opportunity cost helps you in deciding between one financial move vs. another based on making the best move with each dollar you have. Here is two examples.

    (1) You have a debt with an interest rate of 6.8%, while your savings account is earning .02%. You would be wise to put future savings on the debt instead of into savings AND it could also be wise to pull money out of savings (leaving what is needed for an emergency) to pay extra on that 6.8% loan.

    (2) You have a loan with an interest rate of 2.9%. You have money in the bank that is earning .2%. Finally, you have the opportunity to invest in your tax sheltered 401(k) at work into a total stock market index fund with an unknown rate, but with an expense ratio of .05%. Which one do you choose? Most folks would be wise to choose the stock index fund that has returned around 10% on average (it will fluctuate from year to year with some years where it will be below 0%) over the last 90 years.

    Inform yourself on this very important issue by reading Financial Happine$$ and What Color is the Sky as you get your money in the right place at the right time where it is working most efficiently for you. Financial freedom to follow!

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The Crazy Man in the Pink Wig