5 Essential Money Moves for 2016-Read Now!
A quick google search of ‘essential money moves for 2016’ turned up 7,760,000 responses. I’ve done the hard work for you and culled the top money moves into 5 actionable money tips for 2016. Schedule an hour or two and get your finances in order with these 5 essential money moves. (Number 5 may surprise you!)
1. Examine your 401k, 403b or Other Workplace Retirement Account
My spouse has a TIAA CREF account in his workplace 403b. For months I procrastinated the task of evaluating the investment choices in the fund. My goal for this account was to choose index funds with low management fees. I pulled up the online account and looked at the choices offered by his employer. In the list of approximately 10 to 15 funds there were several target date funds with fees over 1.0%. Most of other funds had funds with fees north of 1.0% Then there was one all stock index fund with a fee of approximately 0.61%. The CREF stock fund, which my spouse chose had an expense charge of approximately 0.69%.
In our other accounts most of our investments are in low cost ETFs and index mutual funds with fees ranging from 0.10% to 0.45%. I was hoping to find some comparable low fee index funds in the TIAA CREF offerings available in my spouses 403b. After reviewing all of the TIAA CREF choices, returns, portfolio compositions and fee structure, I decided to stick with the existing CREF stock fund.
How I decided – TIAA CREF is a well regarded company with an option to annuitize the retirement accounts in the future. Although the fees of the CREF stock fund are higher than our other holdings, the management approaches are sound and the returns are reasonable for the risks taken. Additionally, when we examined this fund in conjunction with our other investments and evaluated the total asset allocation picture we found that he tax advantages of the 403b outweighed the decision to invest the money outside this 403b.
Look at the investment choices in your workplace retirement account in totality with all of your holdings. Consider the fees, returns, and your own investment objectives. Make sure that the choices you made previously still hold up today. If possible, always invest in your workplace retirement account an amount large enough to receive the employer match.
Next, consider all of your assets as you enact this second essential money move-asset allocation and rebalancing.
2. Review Your Asset Allocation and Rebalance
Portfolio maintenance isn’t at the top of my ‘to do’ list. It’s similar to those unpleasant tasks that you need to do periodically for life to run well, like cleaning out the refrigerator or dusting behind the couch. The difference between reviewing your asset allocation and rebalancing and dusting behind the couch is that if you miss dusting the consequences won’t impact your retirement. If you skip rebalancing, you are missing out on a potential boost in long term returns along with less volatility or up and down in investment values.
Let’s spell out why you need to rebalance. First, when you began investing, you decided upon an investment mix, in line with your age and risk tolerance levels. Let’s say you chose a 65% stock allocation and 35% bond allocation. In January, your asset allocation was 65% stock funds and 35% bond funds. By the time December rolls around, assume that stocks returns were good and bonds under performed. Thus, by the end of the year you end up with an asset allocation of 75% stocks and 25% bonds.
Not only have your stocks grown quite nicely, they may also be a bit frothy in value. If stocks are a bit overpriced, it’s likely that they may not perform as well in the future. Think of rebalancing as a way to control risk. In simple terms, when you rebalance you sell the better performing asset class and buy more of the underperformers. This process creates a disciplined way to buy lower and sell higher.
In January, Sheila had a $10,000 investment portfolio.
On January 1, Sheila’s portfolio looked like this:
65% – Vanguard Total World Stockk ETF (VT) – $6,500
35% – Total U.S. Bond Market ETF (AGG) -$3,500
Her asset class values were in line with her preferred asset allocation of 65% in stock funds and 35% in bond funds.
By December 30, Sheila’s complete portfolio grew by 10% to $11,000 and the asset allocation percentages were:
75%- Vanguard Total World Stock ETF (VT) – $8,250
25%- Total U.S. Bond Market ETF (AGG) $2,750
Stocks performed better than bonds and thus were a a much greater percent of her portfolio than the bonds.
To control risk and possibly improve returns Sheila rebalanced her portfolio back to the 65% stock, 35% bond mix.
Sheila sold $1,100 worth of shares in VT, the stock ETF and bought $1,100 worth of shares in AGG, the Bond ETF.
After rebalancing her $1,100 portfolio looks like this:
65% – Vanguard Total World Stockk ETF (VT) – $7,150 (65% x $11,000)
35% – Total U.S. Bond Market ETF (AGG) – $3,850 (35% x 11,000)
Certainly, if you have more than 2 funds, the calculations may take a bit more time. But remember, you only need to rebalance once per year. By rebalancing you’ll decrease volatility and may even increase returns.
3. Understand What’s In Your Portfolio-Are You Taking on too Much Risk?
With the Fed Funds interest rate below 1.0% since November, 2008, investors have reached for yield. Are you one of those who bought into high yield junk bond funds? What about other higher return investments?
Now is time to take a gut check.
“There’s no such thing as a free lunch.” In other words, there’s a cost to each choice that you make. And this quote applies particularly well to your investment returns.
If you’re receiving a higher than market rate return on your investments, you’re taking on risk. The ‘risk premium’ is why stocks tend to give you higher returns than a money market fund investment. Investors demand to be compensated with higher returns when they invest in higher risk investments. The recent ‘junk bond’ asset class demise, is a perfect example of the perils of low rated, high yield investments.
I’m not recommending that you stick with a low return government bond fund portfolio, only that you are aware that greater potential returns also exposes your investments to greater potential losses.
Review your investments, especially those with higher returns. That might include real estate investment trusts (REITs), as well as higher yield stock and bond funds. Make sure that you can handle the potential future volatility of returns. In plain language, are you willing to suffer large losses if these investments reverse course?
In a recent CNN.com Money article, “How Can I Get an 8% Return on My Investments?” Walter Updegrage suggests that instead of reaching for unsustainable high returns, in a low interest rate environment, that consumers consider saving more. Although that’s probably not the answer you were seeking, if you’re a conservative investor then it may be the right solution for you.
I suggest that if you want to reach for a higher return, do so only with a small portion of your investment portfolio, such as 5%. And be certain that the risky investments are made with money that you can afford to lose.
4. Do a Gut Check-Can You Handle a Portfolio Decline?
In an earlier article on this site as well as in a U.S. News and World Report, Smarter Investor blog, “Take an Investing Premortem Now to Guard Against Bad Decisions Later”, I talked about doing a ‘premortem‘. Simply put, a premortem is considering before the fact, how you might feel when a catastrophe occurs.
In this case, image that we have a major stock market drop. Don’t think it won’t happen, because at present we are overdue for a normal cyclical correction. Since 2000, according to the NYU Stern Business School data, compiled by Aswath Damadoran, we’ve had 4 years with a negative annual return for the S&P 500. In 2000 the S&P 500 dropped 9.03%, 2001 experienced a negative 11.85% and 2002 was hit with a decline of 21.97. That’s greater than a 30% drop over three years. In the ensuing 11 years, there was only one negative return year for the S&P 500. In 2008 the S&P 500 index dropped 36.55%.
Imagine that your $10,000 investment portfolio is invested 100% in a S&P 500 index fund and the market drops 25% – the value of your investments fall to $7,500. With a 25% market decline, would you be tempted to sell? If so, then you would be locking in your losses.
Every few years, the markets typically experience a negative return year. Bonds also have occasional negative return years. It’s unlikely that in one year both stocks and bonds will have negative returns. That is why you want to diversify your investments across bonds and stocks. So that if your stock investments drop, you’ll have the bonds to prop up the returns.
Make sure you have an asset mix between stock and bond investments that you can live with. Do a gut check and see how you would feel if you saw your investments drop, 10, 15, or even 20%. Adjust your asset allocation so that you can sleep at night.
That’s right–give your money away to those in need. There’s research that suggests that giving to others makes you feel better. In “5 Ways Giving is Good for You” on the Greater Good Website at University of California’s Berkley.edu, authors Suttie and Marsh mention research that links giving to better health. One reason for the correlation is the claim that giving reduces stress.
In a surprising finding, apparently giving increases gratitude, which in turn boosts happiness. Givng has even been shown to increase oxytocin, a hormone that boosts your mood. If you don’t have room in the budget for financial gifts, giving time to others is also beneficial.
To top it off, in some cases you can reduce taxes by deducting your charitable contributions. If you have old stuff cluttering up your home, you may be able to write off the fair market value of your charitable donations to Goodwill, the Salvation Army, or other qualified charity.
Put into action giving when completing these 5 essential money moves.
The Essential Money Moves for 2016 Takeaway
Know what you’re invested in and why. Ignore your avoidance and rebalance your portfolio. Think of others and give-you may even get a tax break. Get these things money moves right and get on with the business of living.