الجمعة، 20 سبتمبر 2019
Some Thoughts on Leverage and Retirement
James writes in:
Do you have any opinions on people leveraging their retirement savings in their 20s and early 30s? You use your retirement savings to buy lots of stocks and other investments on margin, moving all of the risk to the early part of your career. Read a book about it and wanted to know what you think.
I’m not sure which book James read, but there’s a decent chance that it’s Lifecycle Investing by Ian Ayres and Barry Nalebuff, which was a hugely popular investment book several years ago and more or less recommends this exact strategy.
Basically, the authors recommend that young investors – those in their 20s, mostly – leverage their retirement investing when they’re young. Leverage simply means that you’re borrowing money in order to be able to invest more right now, with the idea that you’ll pay back that money in a few years and keep the extra returns.
As a simple example, imagine that you’re 22 years old. You’re putting away $5,000 a year into retirement, which is great, but you want to really kickstart things. So, you borrow $100,000 from someone willing to lend you money (perhaps your brokerage, perhaps a bank, whatever) and you put all of that into aggressive investments, intending to pay it back in ten years.
In that situation, you have a greater than 50% chance of making money on that move and a small chance of making a lot of money, but you have a very significant chance of losing money on that move (because you’re not making enough on the investment to cover the money you borrowed). However, if you are able to do well here, you get a huge jump start on your savings for the future.
If, for example, the loan has a 5% annual interest rate and you earn 10% a year on that money, you could pay the loan back after 10 years and still have $96,000 in savings. On the other hand, if you borrow money at 5% and the stock market only earns you 2% per year, you will owe almost $50,000 at the end of that loan (even after selling off all of your investments) and have nothing to show for it other than that debt.
What you’re doing here is moving a lot of the risk of your retirement savings to the earliest years of your savings. Those first ten years are loaded with risk, but if it turns out well, your retirement savings are very well in hand. If it doesn’t turn out well, you may have a hole to dig out of, but you’re still just in your 30s and have plenty of time to save in a more stable fashion.
On paper, this all seems like a reasonable plan, but there’s a big problem with it: the real world consequences of the downside of this are more impactful than the real world consequences of the upside of this, as compared to simply saving as much as you can and putting it into index funds or target retirement funds within your retirement account.
It simply comes down to some realizations about life.
In terms of your annual living expenses, there’s a certain “happiness point” that, depending on how you calculate it and where you’re at in American, means a significant drop in happiness if you’re below that annual income level and very little difference in happiness if you’re above that income level. Once you have enough money coming in to secure your basic needs and have enough left over for a little bit of travel and a few hobbies, additional money does not add significantly to your personal happiness. This has been an area of significant study in economics and this landmark paper by Daniel Kahneman and Angus Deaton sums it up and even identifies the approximate number – about $75,000 a year in 2010 dollars, varying widely depending on where exactly you live in the United States (much less in some areas, more in others).
The thing is, if you have a decent job and follow a more traditional route to retirement, meaning you put adequate money into a 401(k) or 403(b) or some similar plan, you’ll very likely get to somewhere near that number in retirement, especially when you add in Social Security and other benefits. Of course, “adequate money” means you’re putting in 10% of your pay per year starting in your 20s and that you’re reasonably aggressively invested up until you start getting close to retirement (just putting everything in a Target Retirement Fund matching your retirement year is probably adequate). You are very, very likely to reach that “happiness point” by following this basic plan.
On the other hand, if you use leverage and debt to invest for retirement early on, moving the risk to your earliest career years, one of two things will happen. Either you’ll do well with it and make it easier to save for retirement and potentially early retirement, or you’ll do poorly with it and find yourself in the hole for retirement savings in your early 30s, actually owing money.
The upside? You have some extra cash in retirement or you get to retire several years earlier. You probably wind up a bit past that “happiness point,” which basically means you don’t feel any noticeable difference in your personal happiness level.
The downside? You start your 30s with a big debt on your lap and nothing saved for retirement. You’ll have a harder time even getting to that “happiness point” as you have to both pay off your debt and likely “catch up” on retirement.
The upside is a little more likely than the downside, but the downside is so awful that, in my judgment, it’s not worth the risk for most people. The small amount you gain (some extra money beyond the “happiness point” or a few extra years of retirement) don’t add up to enough to counterbalance the risk of being in extra debt with no savings at age 30.
My advice? Put as much money as you can afford into your retirement accounts as early as you can. If your workplace offers a 401(k) or similar plan – especially if they offer matching – start contributing immediately. Choose a Target Retirement fund if one is available; if not, put the money into something aggressive and low cost, like a Total Stock Market Index. Then, just let it ride until you’re about ten years from retirement, at which point you should start giving it some more focused attention.
The key thing to remember is this: once you get above a certain fairly low financial threshold, you don’t gain happiness. Your best bet for happiness now and happiness in retirement is to aim for that threshold now while also working toward getting there in retirement. That means putting away a small portion of your money now, at a slow pace, and letting it build with aggressive investing so that it can be enough to help you reach that happiness point in retirement. That doesn’t mean taking on enough risk that you add a significant chance of a large amount of debt now and a total depletion of your retirement savings just so you can overshoot that happiness point by a little bit or retire a couple of years earlier.
A bird in the hand isn’t worth two in the bush when it comes to retirement. Invest aggressively, but don’t leverage your retirement, because the downside just isn’t worth the upside. Just keep plugging away. Keep the risk within your investments, not outside of it.
Good luck!
The post Some Thoughts on Leverage and Retirement appeared first on The Simple Dollar.
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Dear Penny: I Just Graduated. Now How Do I Tackle My Student Loans?
Dear H.,
You’re probably armed with a few copies of “Oh, the Places You’ll Go” right now, but not much in the way of cash or certainty.
Fortunately, you’re graduating at a time of low unemployment. You picked a practical field of study. In the words of Dr. Seuss: You’re off to great places. Today is your day!
I wish I could tell you don’t worry, don’t stew. But the truth is, it’s scary when loan payments come due.
OK, enough with the Seuss talk: There are no easy ways to make student loan debt go away, as you probably know.
Your action plan for paying off your debt will depend on so many factors: how long it takes you to find a job and how much it pays, your outstanding balance, and whether you have other debt.
Chances are good that if you have federal loans, they’re currently in a grace period, which is a temporary window you often get to find a job and get your finances together before you have to start paying for that degree. (Private lenders sometimes offer this option as well, but it varies by lender.)
If your loans are in a grace period but are accruing interest, start making payments as soon as you can for at least the interest. But if they aren’t wracking up interest and you find a job relatively quickly, you might take advantage of any grace period to funnel the amount you’ll soon be paying toward your loan into an emergency fund.
Which brings me to my next point: Do you know exactly how much you owe and what your monthly payments will be?
For federal student loans, use the National Student Loan Data System to access information such as your outstanding balance, loan status and who the loan servicer is, i.e., the company that manages your loan. (P.S. Your student loan servicer will always be your starting point if you have a question or have trouble making payments.) For private loans, you can find this info by getting a free copy of your three credit reports from AnnualCreditReport.com.
You can estimate your monthly payments on federal loans using the repayment calculator at studentloans.gov. There are a ton of online calculators that can help you figure out what you’ll owe each month on private loans as well. These will give you an idea of the minimum amount you’ll need to work into your monthly budget.
When the bills come due, you could take the debt avalanche approach, where you prioritize your loan with the highest interest rate first, or the debt snowball method, where you tackle the lowest balance. While technically you’ll save money with the avalanche, paying off student loans is a long-haul journey, so if seeing a loan balance completely disappear will motivate you, the snowball method might be right for you.
But probably the best way to tackle your debt once you find a job will be to keep living like a student so that you can make progress faster. If you can avoid lifestyle inflation by living with a roommate or using public transportation, or if you can take a second job, do it.
A final thought: With all the hype about America’s collective $1.5 trillion student loan debt, you might be tempted to look at getting rid of yours as your only priority. But your student loans are just one piece of your finances. While paying off your debt is important, saving for your future is just as vital — even if that means it will take a little longer to be free of student loans.
As Dr. Seuss said: Remember that life’s a great balancing act.
Your mountain is waiting. So… get on your way!
Robin Hartill is a senior editor at The Penny Hoarder and the voice behind Dear Penny. Send your questions about student loans to AskPenny@thepennyhoarder.com.
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
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Where can I find a new home for my grandchildren’s savings?
Can you suggest a similar children’s savings plan to the plan Baillie Gifford has offered? I have investments for my three grandchildren with Baillie Gifford, which are being discontinued.
I have been given the option to transfer to Hargreaves Lansdown, but l am not happy with its timetable for reinvestment of the funds.
Before providing you with an alternative for your grandchildren’s savings plans, it is worth pointing out that the Hargreaves Landsdown offering is competitively priced, and that Hargreaves Lansdown has also confirmed that it will maintain Baillie Gifford’s low charging structure for the next three years.
In addition, there are lots more funds to choose from in the Hargreaves Lansdown stable than there were with Bailie Gifford. So, in my opinion, Baillie Gifford is not offering a terrible solution to its investors with children’s savings plans. Having said that, you will also find a lot of choice and flexibility via other platforms.
I cannot be sure from your question how these savings plans have been set up, but you may wish to consider using each grandchild’s Junior Isa (Jisa) allowance.
To do so, you will need to liaise with the children’s parents to get the Jisas set up, but once they are up and running you can save as little as £25 a month and top up with lump sums as and when you like until the £4,368 annual Jisa allowance has been reached – and with no restrictions on which investments you can hold within them.
Hargreaves Lansdown charges a 0.25% custody fee and dealing fees are £1.50 for funds and £9.95 for investment trusts and equities.
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Can you explain how annuity payments work and how they are taxed?
Could you explain how annuity products work? Looking at the comparisons in the Best Buys section of the magazine each month, is the first column of figures the amount paid out each month or is the third column this figure?
Also, when buying an annuity, is tax paid on the whole sum put forward or is tax deducted from the monthly contributions instead? Roughly how much monthly income might be attainable from an annuity of £250,000?
We give you the figures for two types of annuity: conventional annuities, which are for people with no health conditions; and enhanced annuities, which can be bought by people who may have smoked or have various other health conditions – these generally give a bigger income than conventional annuities.
Looking at the Best Buy tables in this issue (page 81), the figure in the first column after age is the annual amount you can expect to be paid out if you bought an annuity with a level income – an income that will not change over time.
The amount in the third column is the initial annual income you would get if you wanted your income to be linked to inflation, otherwise known as index linked. This means you will generally receive a lower income at the start of your retirement, but it will increase over time.
This means it should cover increases in the cost of living, including food and energy bills.
In terms of taxation, you can take 25% of your pension tax free before you buy an annuity. Tax will then be deducted from the monthly payments.
The amount of income you can get from an annuity will differ depending on the type of annuity and which provider you choose.
However, as a rough estimate, if you bought an index-linked annuity, £250,000 worth of pension savings should generate an annual income of around £9,000 a year – this equates to approximately £750 a month.
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Bulb Energy is slow to sort out bill error
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Should young people ever pay for financial advice?
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