The Real Reason Big Savers Retire Early: Minimizing Retirement Savings Needs

The Real Reason Big Savers Retire Early: Minimizing Retirement Savings Needs

By Michael Kitces The standard advice in saving for retirement is rather straightforward: save as much as you can, starting as early as you can, to maximize the amount of your savings and how long it has to grow. The more you can get into the retirement account, and the longer that you can let it compound, the more affordable it will be to retire. However, the reality is that trying to increase savings actually has a dual positive effect on reaching retirement: not only does it mean there’s more in the account to grow, but saving more reduces your retirement savings need. The reason, simply put, is that for any given level of income, the more you save, the less you’re spending to live on – and if you don’t spend as much to maintain your lifestyle, you don’t need as much saved up to replace it! In fact, the impact of increased savings (and the associated reduction in spending) can actually go a long way to help bridge the gap for retirement, especially for late-stage savers. On the other hand, for those who are still younger, strategies that help to maintain (but not substantially increase lifestyle), and let future raises be directed towards savings instead, can dramatically accelerate the path towards early retirement as well by controlling the retirement savings need. In the extreme, highly frugal living allows for extreme early retirement, precisely because it facilitates both substantial savings, and doesn’t necessitate much to achieve financial independence given that very frugality. The bottom line, though, is simply to recognize that the reason big savers who live modestly are more...
How Survivorship Bias Happens: Adjusted Fund Rankings

How Survivorship Bias Happens: Adjusted Fund Rankings

By Larry Swedroe One of the problems with some of the research on active management, and also mutual fund performance rankings, such as Morningstar’s popular percentile rankings, is that they contain survivorship bias—they consider only funds that have survived the full period. This contrasts with data provided through the S&P Dow Jones Indices Versus Active (SPIVA) scorecards, which is free of survivorship bias. Its rankings consider all funds that began the period, whether they survived or not. Because we know mutual funds firms don’t merge or shut down successful funds, we can conclude that funds they close almost certainly had poor performance. The problem for investors selecting mutual funds today is that they are choosing from a list that excludes losing funds that have been either shuttered or merged out of existence to make their poor performance disappear. Understanding how survivorship bias impacts the odds of success in selecting actively managed funds that will outperform in the future is an important issue. A Vanguard Study Vanguard’s research department took a look this problem in a study that covered the period 1997 through 2011. I believe many investors will be surprised at how big a problem survivorship bias actually is. Following is a summary of its findings: Just 54% of funds managed even to survive the full 15 years. The rest (2,364 funds) were either liquidated or merged into another fund in the same fund family—in some cases more than once. As you would expect, the leading cause for a fund to fail was underperformance. Funds that failed experienced negative cash flows at the time of closure, as investors responded...
Return of the Cyclicals Following 2016’s Roller Coaster Ride

Return of the Cyclicals Following 2016’s Roller Coaster Ride

U.S. equity investors in 2016 experienced a roller coaster ride. The U.K.’s vote to leave the European Union and the U.S. presidential election each resulted in sharp market moves. Together, the two events contributed to a shift in the underlying fabric of equity markets starting in the second half of the year. While the Brexit vote created huge uncertainty in markets, particularly in Europe, the election of Donald J. Trump and an upbeat assessment by the Fed had an opposite effect: Institutional investors shifted their strategies toward U.S. companies that benefit from economic growth and away from minimizing risk. Money followed investor sentiment in primarily three ways: from defensive to cyclical sectors, from large-cap to small-cap stocks, and from defensive to cyclical (dynamic) factors. Our findings shed light on allocations across sectors, factors and the rest of the investment spectrum. The chart below shows the rotation in sectors and factors in the run-up to the U.S. election. Sectors and factors that reflect economic expansion found favor as investors prepared for what they perceived to be an incoming administration that would champion pro-growth policies. Amid the shift, a rally in small-cap stocks led cyclical sectors such as materials and real estate to outperform (below chart). The MSCI USA Investable Market Index, which is designed to measure the performance of the large, mid and small-cap segments of the market, ended the year up 19.8%. By comparison, MSCI’s USA Index, which tracks the large and mid-cap segments of the market but excludes small-cap stocks, ended the year up 11.6%. The rotation that we witnessed across sectors, factors and small caps also shows that sectors are influenced by...
Behavioral Biases And The Hierarchy Of Retirement Needs

Behavioral Biases And The Hierarchy Of Retirement Needs

Mental Accounting Buckets Various types of “bucketing strategies” have long been popular as a way to both illustrate and implement various retirement income strategies. The classic “time segmentation” strategy typically divides retirement assets into three buckets – a short-term bucket to cover the next few years of spending (invested in cash), an intermediate-term bucket to cover the subsequent 5-10 years of spending (in bonds), and a long-term bucket to cover spending beyond a 10-year time horizon (invested into equities). Notably, such bucketing strategies don’t necessarily produce a materially different asset allocation than a classic diversified balanced portfolio; nonetheless, for an investor who might have a 60/30/10 stock/bond/cash portfolio anyway, it seems to be far easier for most retirees to conceptualize. An alternative version of bucketing is to segment spending longitudinally over time, dividing long-term expenditures into “essential” expenses (the food/clothing/shelter kind of expenses you really can’t afford to outlive), and “discretionary” expenses (the ones that we want, but don’t need to survive, and can be more flexible about). Once expenses have been separated (which can be a challenge unto itself!), assets can be allocated to appropriately match the buckets; for instance, the essential expenses might be paired with Social Security and lifetime immediate annuitization, while the discretionary expenses can be funded with a diversified portfolio. In the financial planning context, these bucketing strategies are often used as a means to help retirees get more comfortable with the impact of market volatility on retirement assets, by deliberately tying retirement accounts to either distant future retirement income needs (the time-segmentation strategy), or the more flexible retirement income needs (the spending-segmentation strategy)....
Do You REALLY Need To Get A Credit Card To Build Credit?

Do You REALLY Need To Get A Credit Card To Build Credit?

By: Manisha Thakor This month, our editors asked a team of experts the questions that have been on their minds. The below is in response to the question: “I don’t own a credit card—too terrified I’ll mess things up! If I pay rent, do I really need a card to build my credit?” With credit card debt causing grief for so many Americans, your fear makes sense. However, not having a credit card means you can’t show you can responsibly use one, and this can have a negative impact on your FICO score, which is used in more than 90 percent of “lending transactions.” Without the plastic, your limited history could prevent you from getting approved for a home mortgage or for borrowing money at a good rate. (It could even sabotage your relationship.) To ease your mind, get a no-annual-fee card, set up monthly auto-pay of the full balance, and charge only one purchase a month (say, your cell phone bill). That way, you won’t incur late fees or have to pay interest on a revolving balance. Click here to read the original...
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