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I am going to establish the need for investments/ savings through the life-cycle model of consumption. I will then walk through standard retirement plans showing that additional funding will likely be needed for the upper-middle class, leading to stock and bond investments, risk tolerance of an individual investor, how that affects diversity and rates of return. On average Americans save approximately 5% of their earnings. This is the lowest among industrialized countries; Japan saves on average 24%, they are the highest savers. The US saves so little in part because of the availability and ease of credit, the financial system; as well as an effective Social Security system. However, the US is changing, to depend on today’s Social Security for tomorrow alone is a risky venture to say the least. Throughout one’s career their earning levels will fluctuate; the highest level of earnings is most likely achieved around middle age or mid-career. It is at this time most Americans begin to think about retirement and savings. The life-cycle model of consumption , Table 1 shows that we desire a constant level of consumption, represented by the straight red line. We, therefore, will go into debt when we are young, repaying the debt and begin saving in middle age, and dissave in retirement. Table 1. Life-Cycle Model of Consumption While I personally believe that savings should being with the first paycheck, I am realistic in acknowledging that most people do not begin to even think about saving or investing until they have reached a certain level of comfort in their income. I will be defining an ideal make-up of a retirement portfolio from the perspective that savings began at middle age or mid-career with approximately 20 years worth of savings. There are several standard means of retirement investing. The U.S. Social Security system is not a bad start, for most however, this is not enough to retire comfortably on. On average, an individual could expect $800 per month from Social Security. An individual who maximized contributions to Social Security could expect $1400 per month. Considering that an individual in his/her prime earnings could be bringing in over $4000 per month, Social Security would not be enough. Employer retirement plans in addition to Social Security are an even better start. Plans for smaller companies include SIMPLE IRAs and SEP plans, a basic definition: contributions are limited, but contributed into by both employer and employee. They offer tax-deductible contributions and tax-deferred investment build-up. Plans for larger companies include 401 (k) and 403 (k) plans, these plans usually allow the employee to choose among several pre-chosen mutual funds, the employer matches contributions, and these contributions are made before taxing income, thereby reducing tax now in the present. And IRAs, which allow a retirement account for nonworking spouses, however, IRAs are not as beneficial as there were originally made out to be. Myth: All traditional IRA contributions are tax deductible. Fact: No, once you attain a higher level of income, ex: $41,000+ for a single unmarried person in 1999 there is no allowable deduction. The exception is if you are not covered by a retirement plan at your place of employment. A Roth IRA’s contributions are not deductible, but the interest is tax-free. Roth IRA’s contributions are limited at $150,000 modified adjusted gross income (MAGI) for married filing joint in 1999. Both traditional and Roth IRAs limit your yearly contribution to $2000. Note: IRA rollovers can be tricky and if not carefully reviewed could wind up costing the investor. A retiree can look forward to his/her Social Security and a pension plan or annuity (401k, SEP, IRA). Will this be enough? Possibly, but do you in retirement want to travel? Afford in-home health care or a retirement home when the need arises? Do you want to enjoy retirement or just live through it? I would like to enjoy a bounty, live better than we do now, be able to travel to visit grandchildren, go to Florida every winter, etc. How can we retire wealthy? By making wise, educated investments. In Table 2, we can see how far $50 a month can go if you start at age 25 and continue until retirement assumed at age 65. In the same table we can contrast that with investing at age 45 until retirement with $250 a month. This table represents the importance of investing at an early age as well as the necessity of the stock market yields of 12% over the course of 15 – 20 years. Every investor is an individual and every investor has a different risk tolerance level. An investor’s risk tolerance is level of comfort an investor has with each investment. Several generalizations can be made about investor’s risk tolerance, some of which are: younger investors are more inclined to risk, while older investors seek security and less risk; education is empowering, an educated investor knows that over the course of 15 years the stock market out performs alternative investments and risk is always fluctuating. An investment portfolio should always be diversified. A diversified portfolio consists of at least 20 – 40 different stocks, bonds, etc. Diversification reduces market risk by 60%. A portfolio should take into account the allowable time horizon as well as risk tolerance of the investor. There are several portfolio styles, aggressive growth, growth, balanced, conservative, and short-term. An aggressive growth portfolio consist of 100% stocks, it is high risk with high return, and should be entered into for at least 10 years. A growth portfolio consist of 70% stock, 25% bonds, and 5% money market, it is high risk with high return and is entered into for at least 7 years. Of these two strategies only a growth portfolio gives the investor some liquidity in the form of the money market mutual fund. A balanced portfolio consist of 50% stock, 40% bonds, and 10% money market, it is of lower risk and lower return and is entered into for at least 4 years. A conservative portfolio consist of 20% stock, 50% bonds, and 30% money market, it is low risk and low return and is entered into for a period of 2 to 4 years. Of these two strategies both are still yielding a return higher than alternatives such as a bank certificate of deposit or savings account. Lastly, a short-term portfolio consist of 100% money market mutual funds, it is a low return and usually invested in for less than 2 years. Note: MMMF are not FDIC. Table 3 displays several bond funds, their risk, and their return yield. To achieve the stock market average of 12% over a period of 15 – 20 years, it is important to include stock funds or individual stocks to one’s portfolio. Municipal bonds and bond funds have the advantage of being having tax-free interest, however, they have a lower return on average than a corporate bond fund. USAA Income Fund Long-Term Bond high 6.48% USAA Growth & Tax Strategy Fund Domestic Hybrid low 2.76% USAA VA Bond Muni Single State Long-term bond average 5.49% Dreyfus Insured Muni Bond Muni National Long-term bond high 4.99% Dreyfus Institutional Short Term Treasury Fund Short-term government bond low 5.58% Kemper State Tax-Free Income Ohio Class A Muni Single State Long-term bond average 4.65% Kemper Short-term US Government Class A Short-term government bond low 5.16% Kemper Municipal Bonds Class A Muni National Long-term bond high 5.18% Investing for retirement is a strategy that should take into account the length of investments (length of time before an investor will need his/her money), amount of principle investment, any continuing payments into your investments, and shifts in the tax brackets throughout a person’s income life. At the beginning of an investor’s retirement investment portfolio with 20 years to go and continual contributions, it would be suggested to enter into a growth portfolio strategy. I see this strategy as the best for long term investing. A growth portfolio allows for some bond investing which has the option of being municipal bonds, interest is tax-free. Of worth consideration, tax managed funds. I feel this is important considering that the investor at the early stages of investing will more than likely be in the highest tax bracket of his/her life. Also of importance is the access to liquid assets such as with the money market mutual funds. No one should have to sell off their retirement investments for emergencies with their home or the marriage of their daughter. As an investor nears retirement, around 5 years until retirement, I would suggest moving to a balanced or conservative portfolio. It is important not to depend on the stock market for immediate needs, since in the short run the stock market fluctuates. Throughout early years of retirement, I suggest staying in a balanced or conservative portfolio. When health has declined and there is immediate need for additional funds, at that time I would suggest moving to a 100% money market account or short-term bond funds, maintaining liquidity of principle. Of course, there are investors whose risk tolerance would not permit him/her to invest in pure stocks and bonds. For this investor they may need persuasion to even consider mutual funds. An investor’s comfort level is very important, for this individual, I would suggest certificates of deposit and savings bonds. While these types of investments do not yield as high as mutual funds or direct stock market investing, they serve a purpose. CDs offer return rates above a standard savings account and they help to fund banks in the big picture of money. My 95-year-old Grandfather has successfully funded his retirement through CDs, a pension, and Social Security. To this day he still invest in CDs and his net worth is six figures. In large, most investors do not want to do the research in selecting stocks, bonds, and money market accounts for their portfolio themselves; at the prime of their career they may not have the time either. A managed fund is an appealing option. A managed fund may cost slightly more, there are management fees involved, typically not more than 2%. Picking a fund lessens the workload, pick a well know fund such as Janis, Fidelity, USAA, Templeton, Putnam, etc. If you have the money, pay someone; an investment fund manager who will take into account who you are. The name on the fund you choose is not so important as they type of fund you choose. Bibliography: Footnoted within Word Count: 1866
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