A Different Way to Save for Retirement

Many financial planners (including me) believe that one of the best ways to save for retirement is to regularly set aside a certain amount of money every week or month, turning saving into a habit.  Retirement plans such as 401(k)s have been structured to encourage this behavior.  However, when you have to make lifestyle changes in order to save, it becomes somewhat like dieting.  It’s hard to keep it up when you feel like you’re restricting yourself from doing something you like.  A recent CNN/Money Magazine article describes a different way of saving called burst saving.  One of the benefits of this approach, according to research firm Hearts & Wallets, is that people who practice it are far more likely to sock away enough money for a comfortable retirement than those who don’t.

The concept is quite simple.  Whenever your income ramps up, such as from a pay raise or from a bonus, put at least 50% of the increase into a retirement account or bank or brokerage account targeted for retirement.  Whenever your expenses drop — for example after your children graduate from college or after you pay off a mortgage — take at least half the amount you would have spent and put it into the same accounts as above.  This approach allows you to save more without feeling like you’re forcing yourself to cut back or to give up something.  And if you can do this for several years, rather than just once, so much the better.

Hearts & Wallets says that burst savers are more likely than other types of savers to hit their savings goals no matter what age they start their savings regimen.  That makes this approach particularly useful for those 40 and 50-year olds who have not been giving much thought to saving for retirement until now.

There are some other things that you can do to increase your savings without it becoming a burden.  One is to set a target for savings.  Studies show that people who calculate how much money they need for retirement end up saving much more than those who don’t.

A variation of the above strategy is to create an auto-escalation plan for your 401(k) or your budget.  For example, you can raise your 401(k) contributions by one percentage point each year for five years, or increase your monthly savings in your budget by 1% each month.  People who do that are much more likely to save enough for retirement than those who don’t.

Keep in mind, also, that those credit cards in your pocket may be the single biggest drag on your ability to save.  Taking on debt for home ownership is one thing, since most of us (with the possible exception of the latest Google and Facebook millionaires) do not have a sufficient level of equity to be able to buy a home fully in cash.  But taking on debt for most other purchases means you are living beyond your means, and that is practically as risky as borrowing money to invest.

We’re all living longer than our predecessors, and government support for our retirement is getting smaller.  Anything you can do to save more now will be well worth it to your future self.

Artie Green, CFP, MBA

Cognizant Wealth Advisors
2600 El Camino Real
Suite 304
Palo Alto, CA  94306
Tel: 650-209-4062

Read More

So, You Like to Invest in Mutual Funds. Know which Shares to Purchase?

If you’re like many investors, you like the diversification and perhaps the active management that many mutual funds offer. And there are lots of resources available for you to identify, compare, and choose funds in which to invest. Let’s say you’ve decided to put some of your money into the Pimco Total Return Bond fund. Fair enough. But which one? PTTAX (the class A shares)? PTTBX (class B)? PTTCX (class C)? PTTDX (class D)? PTTRX (institutional shares)? And why are there so many choices?

The short answer is that each different fund class has a different fee structure designed for a particular market segment. Which can make it very challenging for a retail investor to make the right choice.  Following is a brief explanation and comparison of the different share classes available.

Each share class includes some combination of three types of expenses. First, there are the annual expenses (called expense ratios) which every mutual fund charges. For some funds these charges are less than 0.10% of your investment, while for others they can eat up as much as 3 – 4% of your assets each year. Funds utilizing more active management and/or those focusing on geographies or sectors – small companies in emerging markets, for example, where there is less available information – will typically have higher expenses, reflecting the additional research required. The return to the investor from the fund is equal to the fund’s return less the annual expenses.

In addition to the expenses above, there may be an up-front load, or sales charge, that some mutual fund classes include. There may also be a back-end load, or redemption charge. And, just to add to the complexity, the size of these loads can also vary from one share class to another. While the impact of these different combinations of expenses on your returns will vary based on the length of time you hold the fund, knowing the basic differences between these share classes can help you make better choices even without knowing the future. Let’s compare some of the more common share classes and which are better or worse for investors:

‘A’ shares (also known as investor shares) typically carry high front-end loads, no back-end loads, and relatively low annual expenses. For example, Pimco Total Return Bond fund ‘A’ shares (PTTAX) carry a 3.75% load and an expense ratio of 0.85%. That means that if you invest $10,000, you’ll pay $375 in sales charges right off the bat, leaving $9,625 to be invested in the fund. And each year the investment company will take out an additional. 0.85%. Unless you plan to keep the investment for a very long time, the large up-front fee will significantly reduce your returns (relative to the fund’s returns). Class ‘A’ shares are typically recommended by commission-based brokers since the up-front fee represents their fee for selling you that mutual fund. If you’re buying shares on your own, you should avoid ‘A’ shares.

‘B’ shares typically have no front-end loads, higher expense ratios than ‘A’ shares, and back-end redemption fees, which sometimes decline the longer you hold the shares before selling them. ‘B’ shares aren’t usually very economical either, especially for long-term investors, because of their high expense ratios, as well as their back-end sales charges. For example, the Pimco Total Return Bond fund ‘B’ shares (PTTBX) have a 1.60% expense ratio, nearly twice that of the ‘A’ class shares.

‘C’ shares are commonly known as “level-load” shares. They generally have no loads on either the front or back end, or if they do have a redemption fee, it’s usually much smaller and/or scales down much faster than the back-end loads of ‘B’ shares. But like ‘B’ shares, ‘C’ shares usually have high year-to-year expenses as compared to ‘A’ shares, again making them a bad bet for long-term investors. The ‘C’ shares of the Pimco bond fund above (PTTCX), for example, have the same high expense ratio as the ‘B’ shares. You can also occasionally find ‘N’ shares, which are slightly cheaper versions of ‘C’ shares, but which still carry higher expense ratios than ‘A’ shares).

‘D’ shares are typically sold through mutual fund supermarkets such as Schwab or Fidelity. There are no loads (either front-end or back-end) and the expenses are usually more reasonable. The expense ratio for the Pimco Total Return fund’s ‘D’ shares (PTTDX), for example, is only 0.75%. But there might be a transaction fee you have to pay to the broker, which varies depending on the level of assets you are maintaining with them. Regardless, these are usually the best class of shares to purchase if you are a retail investor.

‘R’, ‘S’, and ‘Z’ shares round the list, and are generally not available to retail investors. ‘R’ refers to shares that are explicitly created for retirement plans. The fees that these funds charge range widely. Some are ultra-low-cost, while others bundle in the record keeping and other administrative costs associated with running the plan. ‘S’ and ‘Z’ are usually share classes that have closed to new investors; if you want to buy into one of these funds for the first time, you’ll have to go through a broker and initially opt for the A, B, or C share class.

The best shares to own are the ‘I’ or ‘Y’ institutional shares – no loads and the lowest expenses in the mutual fund world. Our Pimco bond fund’s ‘I’ shares (PTTRX) carry an expense ratio of only 0.46%, for example. But ‘I’ shares require a minimum investment that is typically out of the range of most investors. For the Pimco fund it’s a cool $1 million! There are, however, two ways you can get access to such fund classes without being Bill Gates. One way is to utilize a financial planner who is also an investment advisor. Many advisors can get you institutional fund shares based on their aggregate investment (across all clients) in the fund or the fund family. Many advisors also have access to load-waived ‘A’ shares of many funds, which have the same low expense ratios as ‘A’ shares but eliminate the front-end loads. They’re not quite as good as ‘I’ shares, perhaps, but certainly better than most of the others. Another way to invest in institutional shares might be through a retirement plan if you work for a large company. Unfortunately, many such plans utilize custom funds whose expenses can be opaque and, in some cases, even more expensive than retail shares.

There are many strategies you can follow for picking a good mutual fund. You can consider cost, or management strategy & expertise, or historical performance, or any number of other attributes. But once you’ve made your selection, paying attention (when the investment company offers multiple classes) to which share class to purchase is a simple way to further improve your portfolio returns.

Artie GreenArtie Green is a CERTIFIED FINANCIAL PLANNER™ Professional with Cognizant Wealth Advisors.  He can be reached at 650-209-4062 or at artie.green@cognizantwealth.com.

Read More