Retirement Simplified

RETIREMENT

**** If you don’t read anything else, just read and consider doing this if you want to save for your retirement and have 15 or more years until or you retire. Open a Roth IRA ( A retirement account) and put in the maximum $5,500 contribution in each year or as much as possible into a total market mutual fund. I suggest a Vanguard fund as it has the absolute lowest fees (lower fee’s=more money in your pocket.) VFINX is the S&P 500 fund aka (the market) meaning it is diversified in stocks, it is up to you if you want to add bonds or a bond fund and what % of your portfolio that would be depending on your risk tolerance. If your employer offers a 401(k) or a Roth 401(k) match program, don’t turn down free money!!! Usually 3-6% of your yearly salary is matched. Try to contribute as much as possible and choose the same mutual fund or a somewhat similar fund with the lowest expense ratio. **** Keep reading below to find out why you should for instance your initial investment 9 years ago of $10,000 would now be $35,985.27

INTRO

Take heed and this will change your life, your kid’s lives, and your family’s lives for generations to come; Today we are talking about investing for the long term via Mutual funds/Index funds, and ETF’s, as well as tax saving strategies, and making sense of retirement accounts offered through your employer (ROTH’s/401(k)’s,) or your own Individual Retirement Account (ROTH/IRA) sand some of their advantages when it comes to taxes. There are others like the 403(b) offered to most nurses or the TSP for government agents but for the sake of ease we will go over these.

The greatest failure of the school system that we graduated from was the utter neglect of personal finance and anything with regards to real life skills. Most folks already have credit cards, car payments, or some sort of debt and we never learned about interest rates and compounding interest and how it works against your wealth but you can get it to work for your wealth. The cycle can end here today. Although I would love to write more about the implications of this lack of knowledge as well as the problems it causes for many individuals/FAMILIES, the growing WEALTH INEQUALITY, and how it leads to DEPENDENCY on government assistance. It is more important to inform about what we can do right now as young adults/professionals to prepare ourselves for the future and for the futures of our kids.

Disclaimer: (I am not legally qualified to offer financial advice) If this brief overview interests you contact a financial advisor. I suggest going through Vanguard. It is also possible how to via: youtube videos, websites like investopedia, podcasts, and reading.  So read you some of them good ol’ books and teach yourself like I did. (Message me for book suggestions; I’d love to help)

(PART 1) SIMPLE MATH, This is why you will give a damn!

1. Consider the S&P500 (the market) with dividends reinvested has returned 15.29% per year annualized or 360% since 2009 lows. In that same time American wages grew less than 30%.

HOLY SMOKES  RIGHT? ************LET ME HELP YOU HELP YOURSELF MAKE SENSE OF THIS

1A.This means for every $1 invested in the market as a whole, you now have $3.60 (this is the annualized CAGR for simplicity)

      $1 x 1.1529^9= $3.598

1B. let’s say you invested a more reasonable amount of $10,000 in 2009 and never added another dime in 9 years.

       $10,000 x 1.1529^9 = $35,985.27   

2. Consider national wages have at MOST only raised  3% in any year since 2009. Lets say that your wage grew 3% per year, more than the national average… If you’re waiting on this pay raise to save you, don’t count on it. Most years it hardly kept up with inflation- (more on that later).

2A. Lets say you made $1 in 2009 and it grew above the national average at 3%

     $1 x 1.03^9= now you make $1.30 a year in 2017….

2B. Again lets say you made something more reasonable in 2009 -$10,000 and it grew above the national average at 3% a year.

     $10,000 x 1.03^9= $13,047 is your 2017 wage.

Now you can see how it is a huuuuge disadvantage to not know about this information, as it could be a major driving force in the growing inequality between Main Street and Wall Street.

(PART 2) THE FEAR FACTOR- BE NOT AFRAID

I know I know, you’re thinking to yourself: “Ayo B, Is there a downside? This is too damn good to be true.” - YES it seems that way. Investing is “risky” but over time the market goes up even if there is a recession, or depression as long as productivity increases, and humans or AI innovate, the market will increase overtime. FEAR NOT, check out my examples below to comfort thee’

During the financial crisis from 2007-2009 the market (S&P500) dropped 50% the worst drop since the Great depression. What this means….

1 A) Let’s say worse case scenario you invested $10,000 in the market, at the peak in January 2007 and immediately after you lost 50% in the following BEAR MARKET (great recession). --- You still made a pretty penny at an annualized CAGR rate of 8.21% and as a long-term investor short-term losses are no sweat off your brow.

$10,000 x 1.0821^11= $23,819

Not bad eh? You more than doubled your investment, investing at the worst time possible.

2. INFLATION IS THE DEVIL- (It depends) but we will get to that later. As you will see in this example it is eating away at your wealth. Using the same example above 2.A) we invested $10,000 January 2007 in a mutual fund that mimics the S&P500 at the worst time possible. Inflation eats away at your returns; it is a measure or the rising costs of goods. In the same 11 year period the actual return adjusted for inflation was 6.26% (shout out to quantitative easing and the Federal Reserve your new friendemy.)

$10,000 x 1.0626^11= $19,501 - solid gains bro.

(PART 3) TERMINOLOGY AND EXAMPLES

Now that I have your attention, It’s time for some schooling to clear up the terms we went over above and also introduce you to new ones.

1.    STOCK----a stock is partial ownership of a public company and entitles you to profits via Dividends or price appreciation.  (stock AKA- EQUITY)

A.    For example, Let’s say Apple (AAPL) has 100 shares outstanding and is sold at $100 a share you can buy 1 share for $100, making you 1/100th the owner of the company. The market cap of the company is $10,000.

B.  Market cap / Shares outstanding = Price (price alone clearly does not indicate good stocks)

2. DIVIDEND--- a payment, paid by a company to share holders. Payments are usually made 4 times a year.

2.A Lets say Apple (AAPL) has a dividend yield of 2%. Every quarter if the price remained constant through the year you will be paid $.50, though price of the stock technically goes down by ? the yield each payment (A high dividend yield does not necessarily indicate a good stock.)

2B Stock ticker- Identification code for a stock (example AAPL for apple)

3. S&P 500- AKA THE MARKET. --The S&P 500 is an American index that follows 500 large Public American companies across all sectors. It is weighted and tracked based on the Market Cap of all 500. Don’t trip yourself out over what this is, just know it is the gold standard of all American index’s and is referred to as the market because it tracks the entire market as a whole.----- 85% of all individual company stocks move up or down with this index on any given day.

3A. The index is comprised of these and many other companies- these are the weights of some of the companies that make up part of the entire index.

IE…. Apple 3.93%, Microsoft 3.12%, Amazon2.6%, JP Morgan 1.71%, Google2.8% , Facebook 1.83%, Visa .95%, Home Depot .91%

3B. Without going to heavy into the math… if Home depot and visa prices are down 1% each for the day, but apple is up 1% then overall the index is positive for the day if all other companies remain unchanged.

4. MUTUAL FUNDS- Because you can not technically “buy the market” AKA the S&P 500 because it is a visual record that tracks market performance. You have to buy what is called a MUTUAL FUND- A mutual fund is a fund that is comprised of certain stocks based on investor demands. So yes you can “buy the market” there are mutual funds that own the market aka the S&P 500’s underlying stocks. THIS IS A DIVERSIFIED MIX OF STOCKS AND SECTORS SO YOUR EQUITY PORTFOLIO IS DIVERSIFIED! Mutual funds can be comprised of bonds or a Stock/Bond blend aka (EQUITY/SECURITY)

Mutual funds have prices that move like stocks do. Mutual funds move up and down like the Indexes depending on the underlying stocks within.

4A. Types of Mutual funds besides the total market fund--- (International/ value/ growth) (Mid cap value) (Bond/ large stock 70/30%) ETC… You may pick a mutual fund depending on your risk tolerance and investment objectives or an irrational gut feeling or because your financial advisor pitched one to you…. Just remember to check the expense ratio of the fund and that past performance does not indicate future performance. You may be a Warren Buffet type and be a Value investor. There is a fund for you, the fund managers allocates stocks to this fund with low P/E ratios among other criteria. These funds historically outperform the market overtime but are more volatile in the short term.

4B. Maybe you want to buy a specific sector. It’s 2014 and the Fed hasn’t raised interest rates in 8 years and they are sitting at 0% so your intuition tells you the The fed wont won’t be as desperate as the EU or Japan and go negative. You also know financial stocks increase when interest rates increase. The entire sector is at a value in your estimation and according to the black swan theory they are the downtrodden sector so the comeback will be strong. You aren’t sure which individual bank stocks to buy so you choose all of them in a mutual fund. GO YOU, you little contrarian you keep this up and you may be Warren Buffet someday.

5. Bonds- AKA SECURITY ---- You lend Governments or companies’ debt and they offer you a fixed stream of interest payments. The principal is returned by the maturity date 1-30 years and you get interest payments. Due to the state of interest rates bonds interest payments may not even keep up with inflation, even if you believe the Fed’s CPI reports.

(PART 4) PRIVATE EMPLOYER RETIREMENT ACCOUNT BASICS

1. 401(k) – THIS IS A RETIREMENT ACCOUNT OFFERED THROUGH YOUR EMPLOYER and is the most common retirement account. It works like a bank saving account but instead of holding cash and collecting interest you hold securities and equities (Bonds and stocks) via MUTUAL FUNDS. This account allows you to invest a % of your paycheck on a pretax basis. This means if you’re under 50 you can stash away up to $18,000 a year and it will not be taxed until you withdrawal. Note- There are penalties for withdrawing and borrowing against it before retirement age. Stay liquid with a savings cushion and you won’t have to worry.

Tax advantage example of 401(k)

1A. Let’s say you make $50,000 a year and you’re a sly MF so you’ll put away $13,000 or 26% of your paycheck. Why are you a slick rick? You know any amount you make over $37,951 is subject to a 25% income tax.

NOTE- I will Round the income numbers down or up to make it easier Remember your income is taxed as you earn each amount so your first $10k in income is taxed at 10% so on and so forth.... follow my example it’ll make sense.

First $10k --------- -------------------------------10% income tax

Any amount above $10k to $37k ------------ 15% income tax

Any amount above $37k to $92k-------------25% income tax

Look at you sheltering your money. You sly dog you! You protected your $13k from the increase in tax rate and taxes for this $13k you protected your money from the feds… for now

You paid $1k on your first $10k--- $10k x .1= $1k

You paid $4.05k on any amount after $10k-$37k-------$27k x .15= $4.05k

Total income tax on your $50k income =$5.05k

$13,000 x .25=    $3,250 Tax saving *for now*

1B. EMPLOYEE MATCH- Let’s say you still put away 26% as in you put away $13K as in the example above. Your employer offers a 5% match at 100% and you make $50k per year as in the example above.

Your employer matches .05 x $50k= $2.5k of free money!!! Add that to the $13k and You put away $15.5k into your 401(k) and selected mutual funds to invest in.

When you withdrawal your money at retirement age it is taxed at your income rate. The growth and principle will be taxed at these income tax rates upon withdrawal. This is the downside…. This leads us to our next retirement account

2. ROTH 401(K)----- THIS IS A RETIREMENT ACCOUNT OFFERED THROUGH YOUR EMPLOYER. The difference is… you pay your taxes before you put your money into the account through different mutual funds, meaning your money grows and compounds for years upon years TAX FREE! Like your standard 401(K) if you are under 50 you can add up to $18K a year into your account per year. Employee matches still apply, but most employers do not offer ROTH 401(k).

2A. Roth 401(k)’s differ from ROTH IRA’s----- Roth 401(k)’s are through employers. Roth IRA only allows you to contribute a maximum of $5,500 after tax dollars per year. Although this seems like a disadvantage, remember most employers do not offer a Roth 401(k). An advantage to Roth IRA’s is the money grows tax-free meaning that when you withdrawal it you pay no tax on the principal or capital gains because you already did.

2B. Roth IRA---- ROTH Individual Retirement Account, meaning you set this account up without a employer. It is limited meaning you can only contribute $5.5k a year but you have more options of investment funds then you will through an employer, you can invest in individual stocks and bonds as well as any Mutual fund, not just those offered through an employer 401(k) account. This gives you more choices on how to allocate your money and find low annual fees. Again I suggest Vanguard funds, simple and low cost.

Roth IRA/ Roth 401(K) Tax advantage examples

3.A) Why do I suggest a ROTH account? let’s take the example of investing $5000 after tax dollars in 1994 (the year I was Born) in a ROTH IRA in a S&P500 market fund via a market mutual fund. If the CAGR annualized return of the S&P 500 since 1994 was 9.68% until 2017 Let’s see how your one time investment of $5000 did in 23 years.

$5,000 x 1.0968^23= $41,869 GAINS FOR DAYS imagine if you put away money

3B. Every year… the math and compounding is much too complicated for an introduction but lets see what $50k in your Roth account would have done in a S&P 500 mutual fund.

$50,000 x 1.0968^23= $418,698

 You don’t believe me? Use this website to move your investments through the past to the present with instantaneous regret at not having pulled the trigger. https://www.moneychimp.com/features/market_cagr.htm

4. IRA- Individual Retirement Account---- is like the standard 401(k) meaning you are not taxed until you withdrawal your money except you have more choice at investment options than the standard 401(k) your employer offers. You can buy stocks, all mutual funds and bonds. The downside is the $5,500 maximum contribution per year.

***Long term Tax disadvantage example via IRA or 401(K)

4A) Lets say you put in $5,000 like example 3A) above

$5,000 x 1.0968^23= $41,869 The same as the example above but lets say you withdrawal all that money this year.

Take into account the tax code.

First $10k --------- -------------------------------10% income tax

Any amount above $10k to $37k ------------ 15% income tax

Any amount above $37k to $92k-------------25% income tax

You paid $1k on your first $10k--- $10k x .1= $1k

You paid $4.05k on any amount after $10k-$37k-------$27k x .15= $4.05k

You paid $1.217K on any amount after $37k-92k------ $4.869k x .25 = $1.217K

TOTAL TAX $6267

Your total amount after withdrawal = $ 35,602

4B) Let’s say you put $50,000 in a market fund in your IRA or 401(k) like example 3B above.

$50,000 x 1.0968^23= $418,698 The same as example 3B, but let’s withdrawl all that money this year.

Take into account the tax code

First $10k --------- -------------------------------10% income tax

Any amount above $10k to $37k ------------ 15% income tax

Any amount above $37k to $92k-------------25% income tax

Any amount above $92k to $191k-----------28% income tax

Any amount above $191k to 416k---------  33% income tax

Any amount above $416 to $418k---------- 35% income tax

You paid $1k on your first $10k--- $10k x .1= $1k

You paid $4.05k on any amount after $10k-$37k-------$27k x .15= $4.05k

You paid $13.75k on any amount after $37-$92k---$55k x .25 =$13.75k

You paid $27.72k on any amount after$92k-$191k-- $99k x .28 = $27.72k

You paid $74.25k on the next amount   ------- $225k x .33 = $74.25k

You paid $.7k on the next amount --------- $2k x .35= $700

You paid $121,470 in taxes! Damn Uncle Sam.

* You should only withdrawal what is needed in that tax year to lower your bill.

Your after tax withdrawal is $297,228

(PART 5) TAKE AWAY AND THINGS TO NOTE

Take away- ROTH’s are better for paying less taxes if you expect your income to rise in the future via capital appreciation. I suggest either Roth accounts to hold your investments if you are investing for the long term.

PLEASE NOTE--- Mutual funds charge Fee’s to hold them. Vanguard usually charges 1/10th of 1% per year… other mutual fund companies’ charge 1% or more per year avoid these. Buying and selling usually incurs a $5 flat rate plus the BID-ASK spread which is marginal, but something to be mindful of. Always assume inflation is here to stay and although it may be good for your mortgage/debt payments it’s bad news bears for your wealth and wealth accumulation. Lastly, The closer the get to retirement age the more Securities or bonds you should own in proportion to equities/stocks/mutual funds, this way you will not loose a large amount close to retirement.

Debt and credit cards

If you already have debt, especially credit card debt, don’t dig your hole deeper. Credit cards often have interest rates between 24%-9%. When deciding which debt to pay off first look for the highest interest rate and the lowest amount of principle.

Final Thoughts

I truly hope to one day be an influence in the school system in order to make personal finance be a mandatory class in high school. Math in personal finance is more basic than algebra 1 (9th grad math) or at least more basic than Geometry or Algebra 2 (10th-11th grade math) and a hell of a lot more useful. Most college kids go through school without taking a personal finance class and that is setting us up for failure and student loans. What better way to make your average high school student give a damn about math than make it REAL. Social Security may not be around for us, maybe not even our parents so hopefully this prepares you a bit or entices you enough to open a retirement account.  Please SHARE this if you found it helpful or think it can help your hard working friends get a leg up in the world. It is a lot to take in and can be overwhelming at first. Maybe start reading or talk to a financial advisor. Break the cycle or just be prepared, your knowledge is power and one day you may be able to help family members and your kids or negotiate a contract with an employer.

 I suggest talking to an advisor for multiple reasons. Most of all they will strongly advise against panic selling and make sense of limit orders, stop order and the like. Most people do not have the gut to withstand a 50% loss in the short term even if they are saving for the long term… You will likely panic and sell at the worst time possible, when it may be the best signaling a time to buy more and at a discount! Print it out and study this if you find it useful. If you need more help check out online resources like investopedia. Watch CNBC to familiarize yourself with financial news but don’t listen too much to their lofty insights.

My personal take on the market is I am a BEARISH. Without getting into my reasoning behind this on a Macro level just know that I’m pessimistic in the short term and am waiting for a correction that I believe to be eminent to get skin in the game. Any one worth their grain of advice will tell you “it is not about timing the market, but time IN the market.” This is remarkably clear through the examples above the longer your time horizon, the less speculative the nature of the investment in the market as a whole….

Hope this helped,

B