3 Tips to Achieve Retirement Goals on Time
For young investors, retirement might seem like a long ways away, but this is the best time to start preparing. In doing so, you aren’t just trying to pick the best assets to own, but you need to come up with a more overarching plan. If you follow these three tips, you will be on your way to achieving your goals.
1. Don’t count on Social Security
There are two reasons for this. The first is that Social Security doesn’t pay a lot. For instance, if you make $100,000 per year and plan to retire at 66, you’re stuck with about $25,000 per year. Clearly that’s not enough to cover your expenses, assuming you want to maintain your living standard.
Second — and this is especially true if you are in your 20s and 30s — you need to be prepared for Social Security to disappear. The program is simply not funded well enough to be sustainable unless contributions rise significantly or unless benefits fall drastically. For a long time, Social Security was in a surplus, meaning that the government took in more money than it paid out.
But it didn’t invest the surplus: It spend this extra money. Right now the government’s unfunded Social Security liability exceeds $17 trillion, and Social Security payments exceed all other government’s annual expenditures. This deficit will only be exacerbated as more baby boomers retire: The number of working Americans supporting each retiree will shrink as the population ages, and this will only put strain on the system.
This doesn’t mean that the system will collapse overnight, but it does mean that we will start to see Congress take measures to increase Social Security income and decrease payouts. For those who plan on retiring in at least 20 years, your best strategy is to assume that the program simply won’t be there, or that its benefit will be minimal. So suck it up, pay the Social Security tax as if it were just another tax and not an investment in your future, and prepare for your own retirement.
2. Invest globally
This is crucial for American investors to understand. As Americans, we are accustomed to investing in American companies that we are familiar with. American companies file their financials and news releases with the U.S. Securities and Exchange Commission in a way that we are used to. They also have uniform – quarterly – dividend payment schedules, and they often return capital to shareholders.
Foreign investments are not just foreign in the geographical sense. They are also more difficult for us to understand. They pay dividends once or twice a year, and they usually base these dividends on profits and not on last year’s dividends. While some buy back shares, many do not. While some file with the SEC, many do not. Finally, foreign companies earn profits in foreign currencies, and so as we convert them, they may seem to be more volatile.
Nevertheless, foreign investments offer unparalleled opportunities. Foreign investments in most cases are significantly cheaper than American investments. Also, many foreign economies are growing much more quickly than the U. S. economy. Turkey is a good example of this.
The iShares Turkey ETF (NYSEARCA:TUR) trades at about half the valuation of the S&P 500, and yet the Turkish economy has been one of the fastest growing in the world. Its population is young, and as younger people reach their 30s, 40s, and 50s, they become more knowledgeable and productive. Yet the Turkish lira is a volatile currency, and we as Americans see headline stories of violent protests in Turkey.
American investors see all sorts of troubling stories about foreign economies, from Columbia to Russia to India, and yet there are incredible opportunities there that the market is ignoring. As a young person preparing for retirement, you need to go against the grain and take the time to locate these incredible opportunities. While it might not seem like it now, as American stocks continue trending upward, doing so is well worth the time and the patience.
3. Don’t underestimate the importance of cash
Cash is a lousy investment. It loses value because of inflation. It generates no returns because interest rates are so low. Finally, unlike a company, it simply does nothing. But having some cash at your disposal is a critical investment strategy for long-term investors because it give you options. Sure, you may be right that all of your investments are worth substantially more than their current valuations. But if you are diversified, chances are that some investment or group of investments in your portfolio will fall, and fall big, in the next several months or years.
That’s just the nature of markets — they are volatile and they never go up or down in a straight line. You have cash to take advantage of this market volatility. If you have cash, then you will be prepared to take advantage of the bargains that will inevitably come along. Even Warrant Buffet’s Berkshire Hathaway (NYSE:BRKA) holds $48 billion in cash and $90 billion in “current assets,” which are almost as good as cash.
Cash may not seem sexy now as stocks are rising, but you might change your mind if the market goes against you.
Many investors have tax-free retirement accounts such as an IRA that allow them to accumulate assets and collect dividends and capital gains tax free. But not many investors know how to take advantage of this situation because they don’t know how taxes impact their investments.
As a bonus, from our previous article on taking advantage of your tax-free retirement account, here is a recap:
1. Buy limited partnerships and REITS
Limited partnerships and REITs are special kinds of corporations. They don’t have to pay taxes, but they are required to distribute the bulk of their profits to shareholders in the form of a dividend. These dividends are not taxed like normal dividends, but rather as ordinary income. As a result they are priced accordingly. But since the market movers are those who are in the highest tax bracket they are priced thusly, meaning that if you are an investor with a small amount of income, or if you put these assets in a tax-free account such as an IRA, you are getting a bargain.
There are lots of these sorts of assets out there. Make sure you understand what the company does before you invest in it. Also make sure that the distribution is appropriate — i.e. make sure it is not too big. A good way to check for this is to make sure the company is not issuing additional shares or debt on a regular basis in order to make payments.
2. Don’t buy municipal bonds
Municipal bonds are already tax free assets if you buy the municipal bonds from your home state (if you buy municipal bonds from another state you will have to pay state, but not federal taxes). As a result the market has priced this in accordingly. So just to provide you with a rough but simple example, if the tax rate is 50 percent then a corporate bond might yield 5 percent, but a municipal bond with the same amount of risk might be priced so that it yields 2.5 percent. Thus there is no point in buying municipal bonds in a tax-free account.
3. Buy corporate bonds
Corporate bonds are taxed at the ordinary income rate, and like with limited partnerships and REITs they are priced accordingly — i.e. they are discounted in anticipation of taxes. Therefore they are good investments for your tax-free account.
The one issue, of course, is that we live in a world with very low interest rates. Therefore when you pick corporate bonds, you need to buy short-duration issues, meaning that they mature soon. If interest rates rise then you won’t be impacted as much as if you had picked long-duration issues. Also, dig deep — don’t buy bonds of well-known large cap companies. There are plenty of small companies flying under the radar that pay high yields to their bond holders because the large bond funds won’t touch them and because people think that just because they are small they are high risk. Find small companies that have steady cash-flow and strong balance sheets, and you will be fine.
4. Buy gold and precious metals
Gold and silver have outperformed every major U. S. stock market index over the course of the 21st century, and yet now they are despised assets. Both gold and silver have played crucial monetary roles throughout history, and this hasn’t changed simply because the U. S. went off the gold standard. If you think gold is a “barbarous relic” as John Maynard Keynes called it then buy silver, which is rapidly becoming one of the most ubiquitous specialty metals used throughout a plethora of industries. It also trades below the cost of production.
Gold and other precious metals are taxed as collectibles at 28 percent. That’s too high. But they’re taxed at 0 percent in your tax free portfolio. You can buy a fund such as the SPDR Gold Trust (NYSEARCA:GLD) or the iShares Silver Trust (NYSEARCA:SLV). There are also many institutions that offer gold and silver bullion for your IRA. Just make sure you shop around in order to find the least expensive providers of these services, and make sure that any company you choose has been approved by the Better Business Bureau.
Disclosure: Ben Kramer-Miller owns shares in limited partnerships, high yield corporate bonds, and gold and silver coins. He is also long the iShares Turkey ETF.