Smart401k Blog

I’m happy to report that I recently found out that I got into the New York City marathon. You can either qualify for it — which I’m not fast enough to do — or you enter a lottery, which is what I did. I’ve been running a lot lately, but now that I’m officially entered, I have to figure out how to run 26.2 miles.

So now I need to develop a training plan that will get my body and mind ready to run a distance that is far longer than I have ever attempted to run. Luckily, I know the distance that I have to run and I have figured out the time that I want to beat. Now, if you’re wondering why I’m writing about my marathon training here, here’s why: while I was figuring out my goal for the marathon, I realized that it was a very similar process to what I went through to figure out my retirement savings goal.

I have always been a goal oriented person, and as a result I’ve taken the time to set a savings goal that I believe will allow me to lead the type of lifestyle that I desire in retirement. Unfortunately, I have found that the majority of people that I talk to haven’t taken the time to do this for themselves.

When creating a plan, the first step is to think about what kind of life you want to live in retirement. Are you planning to travel? Maybe move to an area that has a higher cost of living? Or perhaps you expect to sell your house and move to something smaller? These are just a few of the scenarios that will impact how much you need to save.

The general rule of thumb is that you need to be able to replace 70-80% of your pre-retirement annual income to maintain a similar quality of life in retirement. If you’re not planning any big changes that’s probably a good goal. However, if you’re planning to travel or move to a warmer climate — that’s more expensive — you’ll probably need to be able to replace more that 80% of your income.

After you figure out what type of life you want to lead in retirement, you’ll be able to use one of our calculators to figure out how much you’ll need to save to reach your goal. Once you have that number, you can use it to determine how much you are going to need to save each year to reach your goal. You can then compare those results to how much you are currently saving. If you are ahead of the game, then congratulations! You might be able to retire earlier than you thought, or perhaps you can take that vacation you have been daydreaming about.

If you’re behind where you need to be to reach your goal, it’s time to take a look at how you’re spending your paycheck. There are some easy fixes like drinking the office coffee instead of buying a latte at Starbucks every day, and there are also some bigger fixes like moving to a smaller house or buying a smaller car. But no matter what position you’re currently in, starting now is always a better option than continuing to put off thinking about it.

So back to the marathon… My goal is to run it under 3 hours and 45 minutes which is right around 8 minute and 30 second miles. I’ll keep you updated as my training progresses (the marathon is on November 2nd). If you have any tips for how to prepare for a marathon, I’d love to hear them. Meanwhile, if you have any questions about how to start a retirement plan let us know. We’ll answer your questions as best we can and will try to post our answers here to help others that might be in a similar situation. No question is too small or simple –we’re all beginners in something. For me it’s running… What is it for you?

Scott H

In the headlines

A look at some of the market movers over the past week:

• China Telecom (NYSE: CHA) took a step in China’s massive telecom restructuring by buying China United Telecom’s mobile phone assets
• Standard & Poor’s lowered the credit ratings on multiple major banks
• Homebuilder Toll Brothers (NYSE: TOL) reported yet another quarterly loss
• State Street (NYSE: STT) announced plans to raise $2.5 billion of new capital
• Wachovia (NYSE: WB) ousted its CEO, Ken Thompson
• Investment bank Lehman Brothers (NYSE: LEH) came under heavy fire for it’s capital position and what is expected to be a poor upcoming quarterly earnings release
• Fed chief Ben Bernanke spoke out about the weak US dollar
• GDP growth estimates continue to trend down for both 2008 and 2009
• United Airlines (Nasdaq: UAUA) decided to shutter its low-cost airline Ted
• The JM Smucker Company (NYSE: SJM) announced that it is acquiring the Folgers brand from Procter & Gamble (NYSE: PG)
• Verizon (NYSE: VZ) announced that it will be acquiring wireless carrier Alltel
• Bond insurers Ambac (NYSE: ABK) and MBIA (NYSE: MBI) officially lost their AAA ratings
• A big jump in oil and a rise in unemployment sent the markets plunging on the last trading day of the week

Commentary

It was a rough week for the markets and there was plenty going on. Concern over banks and financial services companies was back in focus again early in the week. Lehman Brothers found itself in an uncomfortable spotlight as speculation ran rampant over the firm’s liquidity position and its upcoming quarter. Wachovia made headlines as well as its CEO became the most recent executive casualty of the housing and credit crisis. Meanwhile, Ambac and MBIA finally found themselves stripped of their coveted AAA ratings — an action that most investors have been expecting for some time.

The economic reports for the week were a mixed bag. In the first four days of the week, we had the Institute of Supply Management (ISM) announce that its closely watched index for manufacturing was unexpectedly up in May. Though the index still suggests that the sector is contracting, the increase was a welcome report against the drop that was expected. Meanwhile, the ISM’s services index fell less than expected in May. Additional positive news came from worker productivity, which gained more than expected, and initial jobless gains, which fell 18,000 from last week.

Of course the economic indictor that most investors ended up focusing on at the end of the week was the surprising jump in the unemployment rate to 5.5%. Compounding this, and helping to spark Friday’s big sell-off, was a spike in oil prices that left crude at nearly $140 per barrel to end the week.

Though the 1.9% gain on the S&P index on Thursday helped mute three down days this week, the S&P finished the week off 2.8%.

Looking ahead

With the stream of earnings reports all but dried up, the market will be looking for news to focus on next week. High on the list is again likely to be economic reports, which will include the Fed’s “Beige Book,” pending home sales, retail sales, and the consumer price index. Many investors and analysts have been concerned about the potential for stagflation — rising prices combined with a slowing economy — so the readings on retail sales and consumer prices should grab some headlines. Current expectations are that retail sales excluding autos will be up 0.7% from April, and CPI will jump from 0.2% to 0.5%.

Despite the market’s sell-off on Friday, the S&P is still up more than 8% from the intraday lows that we hit earlier in the year. And though the magnitude of the sell-off was notable, the news that sparked it on Friday did not seem drastically out of line with the data that was already available and digested.

For retirement savers, we continue to recommend a steady, diversified investment plan that adds new money on a regular, set schedule. Even in a rocky market like we’ve had over the past year, this is still the best bet for capturing the returns from the global economy while minimizing timing risk.

A customer wrote us yesterday and told us that they didn’t need our advice right now because they had pulled all their money out of the market and put it into the money market fund in their account. While this is not the first time this has happened, it still bothers me a great deal whenever I hear about it.

There are certainly very legitimate reasons to move your retirement money into a cash-equivalent investment like a money market or stable value fund.  When you don’t have the time to ride out shorter-term ups and downs of the market, you may need to get more conservative with your money.  But the more frequent reason people pull out of the market is flat out nervousness.  Many people that get nervous about the markets are tempted to pull their money out before (they think) things could get worse.  When the market starts to go back up, the plan is to jump back into their original investments, reaping the rewards of future market gains. 

Well, I’m here to tell you two things: 

1.  Pulling out of the market whenever you fear further declines is a form of market timing

2.  Market timing is extremely risky and can easily cost you tens of thousands of dollars if your timing is off the slightest bit.  Read on to get the facts. 

Goldman Sachs Asset Management did a study that looked at market returns as represented by the S&P 500 Index from 1986 to 2006.  Here is what the data shows:

Stay invested in all 5,297 days of this study period, and the annual return is 12.12%

Miss the 10 best days and the annual return is 8.56% - a difference of 3.56% per year.

Miss the best 40 days and the annual return drops to 1.87%.

Miss the best 70 days and the annual return drops to -3.02%. 

As the data above indicates, if you are out of the market only a handfull of key times, your returns can be severely impacted.  What does this return difference mean in terms of dollars in your account at retirement?  Let’s say you just missed the 10 best days over the above 20 year period, saved $400 per month for all of those 20 years, and had a return on your investments of 8.6% (rounded for our calculator) per year.  You would have $254,500 after the 20 years.  Under the same assumptions, except if your return were instead 12% per year (rounded for our calculator), you would have $ 399,700 - a difference of over $145,000 (these are before tax numbers).  And that’s only 10 days! Imagine if you had missed the top 70 days, just over 1% of the days covered in the time period, and lost money! 

Given these numbers, is it really worth the risk of going in and out of the market?  We think not.

-Scott Revare

The returns listed are based on the S&P 500 Index, which is the Standard & Poors’ 500 composite stock price index of 500 stocks, an unmanaged index of common stock prices. The index figures do not reflect any deduction for fees, expenses or taxes.  Past performance is not indicative of future results.