Investing for Retirement

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The Backdoor Roth

Post by dfw_pilot » Sat Oct 21, 2017 9:53 am

Yeah, that's right - to do a backdoor Roth, it's really pretty simple. When you are over the income limits for a Roth (if you are married filing jointly, make sure to do two Roth's) just put it into the Traditional IRA, which has no limits. Then, since 2010, it's been legal to simply convert the new $11,000 to a Roth. If you do it in a few days, and initially put the funds into a money market account, you'll have zero gains, and thus zero tax to pay upon conversion. Finally, you'll fill out form 8606 (easy) when you file your taxes.

Watch out for the Pro-Rata rule, which states that the calculation for tax upon conversion counts ALL IRA, SEP and Simple IRA money. If you have any IRA money, roll it over into your 401(k) first, then do the backdoor Roth. If you don't, you'll owe tax on all the money in your IRA, not just the new $11,000 you convert.

I'd highly recommend considering switching to index funds. More diversification, lower fees, and less volatility. There is also a lot to be said about dividend stocks that's beyond this post. However, I'll say that some of the best stocks, like BRK, don't pay one. The thinking is that it's better for the company to grow itself, than pay a dividend. Plus, with a dividend, you owe tax no matter what, whereas if you sell stock for income, you get to determine when and how much tax you pay. Sell some stock or get a dividend; it's the same thing, but the latter gives you much more control.

In the end, I've followed the no-dividend strategy as much as I can. You can read more about why avoiding dividends might be right for you, both here and here.
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Re: Deferral Limits

Post by massgrass » Sat Oct 21, 2017 10:14 am

dfw_pilot wrote:
Fri Oct 20, 2017 9:50 am
The IRS has officially increased the personal 401(k) deferral limit to $18,500 for 2018.

If you are one to max this out, I highly recommend maxing it out as early in the year as you can, via "front loading."
Perhaps not. Another tax reform trial balloon floated:

There’s talk of capping 401(k) contributions at $2,400 per year

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Re: Investing for Retirement

Post by dfw_pilot » Sat Oct 21, 2017 10:17 am

Agree - tax law changes, but until it's written in stone, I ignore it. Too much drama and distraction for me if I don't ignore it! Some of the changes sound appealing, other parts don't. We'll all have to wait and see if Congress acts. Until then, I'm mapping out my 2018 budget now.
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Re: Investing for Retirement

Post by massgrass » Sat Oct 21, 2017 10:45 am

Yeah, it's yet another idea thrown out into the ether. Many of the things coming out about how these proposed tax cuts will be paid for will make certain groups of people very angry, and there are lobbyists for just about everything these days.

I just hope that whatever happens will be in early 2018 so I'll have more time to prepare. I'm going to have a kid starting college, some credits/deductions could be going away, I don't know what the tax brackets will look like, I don't know how this will impact my retirement savings options, etc. Good times. :|

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Re: Investing for Retirement

Post by dfw_pilot » Sat Oct 21, 2017 10:50 am

I hear ya!

One thing that angers me about the talk coming out of D.C. and in the media is tax cuts that should be "paid for." Uh, sorry, it's my money in the first place! Businesses, families, and individuals often have to cut back, but our betters in Washington never seem to want to.
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Re: The Backdoor Roth

Post by gatormac2112 » Sat Oct 21, 2017 8:43 pm

dfw_pilot wrote:
Sat Oct 21, 2017 9:53 am
I get what you're saying about tax implications of dividends, but I'm not getting a dividend payout, they're qualified dividends being reinvested in the same stock in my tax advantaged 401k. I'm not currently seeing any tax hit. I'm just getting more shares of stock. And I don't pay any fees for my stock outside of the $4.95 per trade I think it currently sits at. The 18 stocks I have are pretty diversified across sectors, but it would be foolish to claim that they are anywhere near as diversified as an index fund. I've also chosen proven companies at value with an expected upward trend so that my portfolio isn't just churning out nothing but 2-3% dividends. Once they reach overvalue its time to sell and move onto some more value offerings.

Its worked for me, but honestly just selecting some index funds would be so much more simple and probably just as good in the long run.

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Re: Investing for Retirement

Post by scarlso2 » Tue Oct 24, 2017 12:40 am

Great stuff! I'd switch 3) and 4) of Part Two, but agree with just about everything else. When can we expect the write-up on the Mega backdoor for those who have very kind employers?

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HSA vs 401(k)

Post by dfw_pilot » Tue Oct 24, 2017 7:16 am

Regards to 3 vs 4, it probably depends on a lot of things. I'd be more inclined to max out true retirement accounts first, for for fewer strings attached spending and the overall higher amounts of money one can put away. But the best answer of course, is to max everything out :). Stealth IRA's are great though, and I wish everyone had access to them.
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Re: Investing for Retirement

Post by Ware » Tue Oct 24, 2017 7:48 am

scarlso2 wrote:
Tue Oct 24, 2017 12:40 am
Great stuff! I'd switch 3) and 4) of Part Two, but agree with just about everything else. When can we expect the write-up on the Mega backdoor for those who have very kind employers?
I agree - maxing the HSA (after taking advantage of any employer 401k match) before going back to fill the 401k saves you the additional 7.65% in FICA withholdings on the front end. Then at retirement the best case is you use the money for medical expenses, and the worst case is you use the money for anything you want. Also, there are no required minimum distributions (RMD) with an HSA. So I would say it is more desirable than a 401k pretty much any way you slice it. I think it's also not uncommon to see more lower fee options in an HSA than an employer sponsored 401k.
Last edited by Ware on Tue Oct 24, 2017 8:01 am, edited 1 time in total.

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Re: Investing for Retirement

Post by dfw_pilot » Tue Oct 24, 2017 8:21 am

Good call, guys, I'll make the switch. I don't have an HSA or pay FICA, so I learned something, too!
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Re: Investing for Retirement

Post by Ware » Tue Oct 24, 2017 9:31 am

It’s kinda like lawn care - everyone’s situation is a little different, and there is more than one way to get there. :thumbup:

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Best HSA

Post by dfw_pilot » Tue Oct 24, 2017 10:06 am

How timely. I got this in my inbox this morning about some of the best HSA providers.
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Re: Best HSA

Post by pennstater2005 » Tue Oct 24, 2017 10:42 am

dfw_pilot wrote:
Tue Oct 24, 2017 10:06 am
How timely. I got this in my inbox this morning about some of the best HSA providers.
I love TFB! Good info there.
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Re: Investing for Retirement

Post by llO0DQLE » Tue Dec 05, 2017 3:11 am

Wow nice post! I've actually stepped back from the lawn hobby this year to focus more on the family finances and to learn about investing. Thanks DFW!

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Re: Investing for Retirement

Post by HoosierHound » Thu May 03, 2018 10:31 pm

@dfw_pilot, I'm curious about the reasoning behind your asset allocation advice, especially regarding bond investing.

While the advice of including bonds in a retirement portfolio, sometimes in large percentages, is rather common, I completely disagree with this advice. Your "risk tolerance" should not be based on your age or on your ability to sleep at night, it should be based on the length of time you intend to be investing. For retirement, that length of time is decades, about 30-60 years depending on what age you start and your life span.

If you invest $10,000 in a stock index with average annual return of 10% versus a bond index with an average return of 5%, over time the differences are huge:
After 30 years: $158,000 vs $41,000
After 40 years: $411,000 vs $67,000
After 50 years: $1,067,000 vs $109,000

My rather blunt assessment is that if you are losing sleep at night because there are days when stocks decline in value, then the solution should be to gain more investing knowledge, and not trade the high-return of stocks for the low-return of bonds. The amount of money you are giving up over the long-term by investing in bonds is what should cause sleep loss.

I also maintain strong skepticism about international investing, although I will readily admit that I don't base it on detailed research. But a combination of what research I have done, along with intuition, leads to my opinion that international stock returns are too heavily weighted by currency exchange rates. The exchange rates, in turn, are influenced by all sorts of international political and economic factors that are difficult to predict and plan for, including government policies and investor speculation. International stock returns have historically been underwhelming, in my view, reflecting the influence of these factors and not offering sufficient compensation to the investor for the risks.

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Bonds and International Funds

Post by dfw_pilot » Thu May 03, 2018 11:18 pm

I don't invest in international bonds for the very currency hedge you mention. However, that risk is less with stocks, so I have them in my portfolio (VTIAX). It's a cheap way to diversify. It also protects against being too home-centric. The Japanese stock market crash in 1991 is a prime example why holding funds outside one's country can be wise. But, the world economy is truly global, and most large corporations have money spread all around, so only investing in US stocks is fine, too. That's what Jack Bogle recommends. Neither is right or wrong. Remember, there are many roads to Dallas.

As far as bond allocations, let me just bluntly say this: investing is 90% behavioral and only 10% math. You used 10% growth for stocks and 5% growth for bonds. Those are tidy numbers, but hardly guaranteed. There are many people now thinking that bonds may out perform stocks in the next decade. My crystal ball is hazy, so I don't know. But my point is that those returns won't always look like that. Sometimes new investors need a little "bond assurance" to keep them from selling out when stocks collapse. By having a reasonable allocation of stocks and bonds (60/40? 70/30? 80/20?) not only may help them stay the course, but it will also allow them to have money available to buy stocks whilst they are down and cheap. With a high stock allocation during a downturn, one can run out of bond money for rebalancing real fast. The brilliant William Bernstein makes this very point in his excellent book Four Pillars of Investing. If you, Hoosier, or anyone reading, hasn't read that book, I highly recommend it.

In a perfect world, yes, all high schoolers should be in 100% in stocks, hopefully an S&P 500 fund, and forget it until they are 60. But, we don't live in a perfect world, and most people don't invest from the time they are very young. Remember too, that adding bonds can actually increase your return over a 100% stock allocation.

Each individual must decide on their own what their tolerance will be for down markets. That can only happen if they've experienced a real correction like 2008. We've been on a huge bull run for the last nine years, and there are lots of confident investors out there, many of whom are heavy into stocks. That works great until the next collapse. Remember that sequence of return risk is real. Like Buffett says: "Only when the tide goes out do you know who's been swimming naked."

Wade Pfau, Michael Kitches, and others have discovered that a rising equity glide path can make a lot of sense, and I agree. But, for general advice to those I don't know personally, I feel better offering the advice Bogle offers on bonds, even if the math might prove it wrong in theory. And even though stock to bond allocation is important, it's fairly far down on the list of things to get right. Invest for a long time, every month, with 20% of your income, maxing out retirement accounts, and being faithful to your IPS are the big things that help people win in the long run. Which US or International fund, or how many bonds one should have, is, while interesting to talk about, much less important. So that's my thinking on the reasoning for my post. We don't always have to agree, because there are many roads that thankfully end up in the same place.
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Re: Investing for Retirement

Post by HoosierHound » Fri May 04, 2018 10:49 am

This is awesome, I really enjoy discussing these things! All of my opinions are offered in a spirit of good will. I intend no disparagement, only discussion, and I take no offense at any disagreement. :D

I agree and use the axiom that investing (actually all personal finance) is 90% behavior. If anyone is reading this discussion about investment asset allocation and has not accomplished any of these other goals first, you need to stop and work on your personal finance behavior, since that will lead to 90% of your results.
1) Write and follow a household budget every single month
2) Using the budget, spend less money than you make
3) Pay off all non-mortgage debt, and don't acquire any new debt
4) Save up an emergency fund
5) Invest at least 15% for retirement, or even better 20% as dfw_pilot suggests
6) Optional and probably irrelevant: Over-analyze and debate your asset allocation :lol:

I would like to make two points, that I think often get overlooked in discussing retirement investing. The first point is how the time horizon for retirement investing is determined. Someone's retirement investing horizon is the first to occur of two events, either when they run out of invested funds or they die. Many people, including financial advisers, instead use the date of retirement as the time horizon for retirement investments. This is a mistake. No wise investor withdraws all their invested funds and holds them in cash on their date of retirement. These funds will continue to be invested throughout retirement. This means that even if someone is 60 years old today with a life expectancy of 85, then they still have 25 years of retirement investing. So while there are periods of time when stock market returns are relatively low, that has never historically been true over decades of time.

The second point is that investment management post-retirement, when you are no longer making new contributions to your investments but making withdrawals, is significantly different for pre-retirement, when you are making regular contributions and not withdrawals. And so, while my previous point remains that many people need to view their retirement investments with a longer time horizon than they do, they also need to make sure their current strategy is suited for whether they are pre- or post-retirement.

I read the article proposing a "rising equity glide path", and the first point to make is that this is an article discussing post-retirement strategies when withdrawals are being made. No one should use it to guide investment decisions of pre-retirement contributions and wealth accumulation. Additionally, I found the article unconvincing.

The highlighted comparison between beginning retirement with only 30% stock exposure compared to 60% increased the odds of supporting a 4% withdrawal rate over 30 years from 93.2% success to 95.1% success. Is that even statistically significant? Per their own analysis, a 100% stock portfolio would succeed at this goal 88.3% of the time. Is that such an undesirable result? Assuming practical adjustments to the withdrawal rate, rather than fixing it at 4% every year, would likely boost the success rate to 100% for an all-stock portfolio. But completely left out of the analysis is the upside potential that the investor gives up. Why the intense focus on the worst case scenarios? How much wealth is the person giving up in more likely scenarios by decreasing their stock exposure so significantly during retirement, just to have a tiny marginal benefit in the worst case scenario? Also left unexplained is how the portfolio will start retirement with a 70% bond allocation in the first place. What sort of investment returns are being lost and how much market timing risk is being added to adjust a portfolio to that balance at or before the retirement date?

They ultimately characterize their proposal as a type of bucket strategy. But a post-retirement bucket strategy (which I advocate) is built around income and withdrawal demands, not a percentage portfolio allocation. Once the short-term cash and medium-term bond buckets are funded, then all remaining funds can be aggressively invested for greater returns. But again the size of the cash and bond buckets is determined by the income needs of the investor, not as a percentage of the overall portfolio. So depending on how much wealth was accumulated prior to retirement that could result in 70% cash and bonds for one investor and 10% cash and bonds for another.

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Bonds

Post by dfw_pilot » Fri May 04, 2018 11:14 am

I'm not brave enough to disagree with the likes of Pfau and Kitces. That said, lots of good points, none of which really contradict what I've previously posted.

"Following the age-in-bonds method, if you are 20, have an 80/20 stock to bond split, and if you are 60, have a 40/60 split. This is fairly conservative, but probably something you should consider as it’s what John Bogle (founder of Vanguard) advises. Another good rule of thumb is to never have more than 75% or less than 25% bonds.

I am personally at 85/15 at age 40. People like POF are mid 40's at 90/10, while others like WCI are at 75/25. With one's head in the game, higher stock allocations are just fine. However, for folks who don't live and breath this stuff every day, they'll have to be very careful about their behavior if a downturn does occur. Further profits after retirement are just fine. I have no qualms with people reaching for yield, even in retirement. But at some point, once somebody has won the game, there isn't much need to keep playing, imo. I think wealth plays another factor in deciding allocation once in retirement. If one has "just enough" they should probably be more conservative than someone who can cover their yearly expenses plus a lot more.

Personally, my plan is retire with a few years worth of income in bonds, and keep the rest in stock index funds. With a 3.5-4% withdrawal rate, I hope to die with more money than I retired with, for my heirs sake. If others want to do the same, as long as they know their own personal behavioral risks, I say: Have at it!
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Re: Investing for Retirement

Post by SGrabs33 » Fri May 04, 2018 11:45 am

Always one of my favorite threads @dfw_pilot
Thanks for your contribution @HoosierHound

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Re: Bonds and International Funds

Post by Grass Clippins » Fri May 04, 2018 9:01 pm

dfw_pilot wrote:
Thu May 03, 2018 11:18 pm
I don't invest in international bonds for the very currency hedge you mention. However, that risk is less with stocks, so I have them in my portfolio (VTIAX). It's a cheap way to diversify. It also protects against being too home-centric. The Japanese stock market crash in 1991 is a prime example why holding funds outside one's country can be wise. But, the world economy is truly global, and most large corporations have money spread all around, so only investing in US stocks is fine, too. That's what Jack Bogle recommends. Neither is right or wrong. Remember, there are many roads to Dallas.

As far as bond allocations, let me just bluntly say this: investing is 90% behavioral and only 10% math. You used 10% growth for stocks and 5% growth for bonds. Those are tidy numbers, but hardly guaranteed. There are many people now thinking that bonds may out perform stocks in the next decade. My crystal ball is hazy, so I don't know. But my point is that those returns won't always look like that. Sometimes new investors need a little "bond assurance" to keep them from selling out when stocks collapse. By having a reasonable allocation of stocks and bonds (60/40? 70/30? 80/20?) not only may help them stay the course, but it will also allow them to have money available to buy stocks whilst they are down and cheap. With a high stock allocation during a downturn, one can run out of bond money for rebalancing real fast. The brilliant William Bernstein makes this very point in his excellent book Four Pillars of Investing. If you, Hoosier, or anyone reading, hasn't read that book, I highly recommend it.

In a perfect world, yes, all high schoolers should be in 100% in stocks, hopefully an S&P 500 fund, and forget it until they are 60. But, we don't live in a perfect world, and most people don't invest from the time they are very young. Remember too, that adding bonds can actually increase your return over a 100% stock allocation.

Each individual must decide on their own what their tolerance will be for down markets. That can only happen if they've experienced a real correction like 2008. We've been on a huge bull run for the last nine years, and there are lots of confident investors out there, many of whom are heavy into stocks. That works great until the next collapse. Remember that sequence of return risk is real. Like Buffett says: "Only when the tide goes out do you know who's been swimming naked."

Wade Pfau, Michael Kitches, and others have discovered that a rising equity glide path can make a lot of sense, and I agree. But, for general advice to those I don't know personally, I feel better offering the advice Bogle offers on bonds, even if the math might prove it wrong in theory. And even though stock to bond allocation is important, it's fairly far down on the list of things to get right. Invest for a long time, every month, with 20% of your income, maxing out retirement accounts, and being faithful to your IPS are the big things that help people win in the long run. Which US or International fund, or how many bonds one should have, is, while interesting to talk about, much less important. So that's my thinking on the reasoning for my post. We don't always have to agree, because there are many roads that thankfully end up in the same place.
"There are many people now thinking that bonds may out perform stocks in the next decade." You may want to research the relationship that bonds have to rising interest rates.

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