by Stephan Cassaday
June 12, 2017
For most Americans, financial insecurity, a lifetime of compulsory work and dependence on government safety nets later in life is a very real possibility. This is the case because young people typically do not proactively plan for their lives 30 years in the future. Proper habits and small incremental behavioral changes, especially when initiated at an early age, can more fully assure accumulation of sufficient wealth for a comfortable, worry-free retirement. Financial success requires sacrifice, discipline and adherence to three basic investment principles.
Sacrifice means different things to different people, but it does not mean forfeiting all fun things and living like a cockroach. Reasonable sacrifices include giving up one or two discretionary spending items and putting away the money saved in a retirement plan. 401(k) and 403(b) plans, and their ilk, are the best overall way for young people to save for retirement. They are convenient, painless and have outstanding tax advantages. If you are not participating in your company retirement plan, roll up this paper, swat yourself on the head, then call your HR department and get signed up. Although not guaranteed, relatively small amounts saved regularly in investments that have a higher return potential can result in massive long-term accumulations. However, starting early is imperative. Assuming an 8 percent return, if retirees each save $100 per month beginning at age 25, they could accumulate $351,000 by age 65. If they wait until age 30, they would accumulate $231,000. This is a significant difference and should be motivation to start early.
Discipline means that you make the sacrifice required to free up the money necessary to have a savings plan, implement it and stick with it. You must resolve to spend time thinking about your savings plan and make a commitment to stick with it —for decades — rather than blithely sailing along thinking that money will magically appear in your accounts. It won’t — it’s up to you. Discipline also means that you are conscientious about setting savings goals, that you pay yourself first by putting money away every paycheck and that you have a budget and know what you can spend and save each month. Spending as much time planning your future as you do planning one vacation is discipline.
Once you are committed to making small, incremental behavioral changes in a disciplined, organized and thoughtful manner, the next step is to unfalteringly adhere to three basic investment principles.
The first principle is to remain diversified. This means your portfolio should have money in each of these four asset classes: stocks, bonds, hard assets and cash. There is no other place that you can put your wealth. Adjust your risk level to fit your tolerance by varying your allocation between the risky (stocks and hard assets) and more stable (bonds and cash) asset classes. Although it may make you uncomfortable, taking some risk may be essential. Historically, the tradeoff for fluctuations in portfolio value due to the presence of risk has usually, but not always, been higher returns.
The next principle is rebalancing. This is an important yet often overlooked part of the investment process. Simply stated, rebalancing prunes your portfolio back to your target allocation at regular intervals. This should happen at least annually. Rebalancing forces you to sell high and buy low, the basic axiom of successful investors. For example, generally when your stock allocation is above its target, it has outperformed the other asset classes. A rebalance would take money from stocks and add it to an underperforming asset class. Without rebalancing, portfolio allocations become distorted over time and may no longer reflect the investor’s risk tolerance and return objectives.
The final principle is to avoid the temptation to time the markets. Although opinions vary, our research as well as that of others does not support the contention that one can time entries and exits to improve investment results. More money is lost trying to avoid declines than in the declines themselves.
Small sacrifices and discipline at an early age, along with remaining fully invested and diversified with regular rebalancing, may be the key to a more worry-free retirement.
Stephan Cassaday is a 40 year veteran of the investment industry and founder & CEO of Cassaday & Company Inc., an independent wealth management firm in McLean. It is rated by Barron’s as No. 1 in Virginia and one of the top 100 advisors in the nation.