Retirement Savings Advice

Question

just a typical financially illiterate American guy here looking for advice on how to make my retirement more financially fit. Soon I will be a U.S. federal government employee and will therefore have access to the Thrift Savings Plan. I figured this is a good time to refresh my savings strategy.

First, some information about me which might help to shape any advice you can provide:

• single, mid-30s male
• no dependents
• healthy
• student loan debt: ~$14,000 @ 3.125% interest rate

Right now I have an American Funds account and a Vanguard account. Details are below. About 10 years ago, an American Funds advisor set up the American Funds account for me. He also provided suggestions on choosing an investment mix for the Vanguard account, which was available through my previous employer. Honestly, I haven't heard from the guy in years.

American Funds Account

All Return percentages are since fund inception date.

Investment Accounts, Class A Shares:

Fund                                Expense Ratio  Return
Capital Income Builder (CAIBX)      0.59%          8.95%
The Growth Fund of America (AGTHX)  0.64%          13.52%
New Perspective Fund (ANWPX)        0.75%          12.17%

Retirement Accounts (CB&T CUST ROTH IRA), Class A Shares:

Fund                                          Expense Ratio  Return
Capital World Growth and Income Fund (CWGIX)  0.77%          10.46%
Fundamental Investors (ANCFX)                 0.60%          12.36%
The Growth Fund of America (AGTHX)            0.64%          13.52%
New Perspective Fund (ANWPX)                  0.75%          12.17%
New World Fund (NEWFX)                        1.04%          7.99%
SMALLCAP World Fund (SMCWX)                   1.07%          9.62%

Vanguard Account

Through my previous employer, I have a Vanguard Plan C 403(b) account in which contributions were made pre-tax. The investment mix is 100% stocks. All Return percentages are since fund inception date.

Fund                                        Expense Ratio  Return
PRIMECAP Fund Admiral Shares                0.32%          10.67%
Small-Cap Index Fund Institutional Shares   0.04%          9.04%
Total Int Stock Index Fund Inst Shares      0.09%          5.89%
Windsor Fund Admiral Shares                 0.21%          7.64%

Thrift Savings Plan

For 2017, the average net expense was $0.33 per $1,000 invested (source). Now that I have access to the Thrift Savings Plan, I need to decide on an investment mix and if I should move money from the American Funds and Vanguard accounts into the TSP.

Questions:

1. After taking Vanguard's investor questionnaire survey, it seems a reasonable TSP investment mix for my situation is to contribute 90% to the C Fund and 10% to the G Fund. The Lifecycle Funds sound ideal but their return since inception averages ~6%. Advice?
2. Considering the high expense ratio of American Funds, I am thinking about closing that account and transferring the money to either Vanguard or the TSP. Advice?
3. I have 3 months of pay ready for an emergency fund and was thinking about placing the money into either a Vanguard money market or high-yield savings account. Advice?
4. Going forward, I am curious how financial advisors calculate an investment mix for a client. Is there a recommended formula that adjusts based on a persons age and financial situation? I'd love to see it.

Thanks!

Answer 1

Considering the high expense ratio of American Funds, I am thinking about closing that account and transferring the money to either Vanguard or the TSP. Advice?

How have their historical returns compared? A higher expense ratio is not necessarily bad if the excess historical return has exceeded the excess expense ratio.

I have 3 months of pay ready for an emergency fund and was thinking about placing the money into either a Vanguard money market or high-yield savings account. Advice?

Either should be fine - they will give you a small return and are very liquid, which is the main criteria for an emergency fund.

Going forward, I am curious how financial advisors calculate an investment mix for a client. Is there a recommended formula that adjusts based on a persons age and financial situation? I'd love to see it.

It's more of an art than a science, and subject to debate. Many feel that risk should go down the closer one is to retirement; others feel that unless the income generated is barely sufficient to cover living expenses, then it's "ok" to continue to have a risky portfolio since you can benefit from better returns (on average), and there's less change that the portfolio will not sufficiently support you financially. So there are "rules of thumb" out there (e.g. invest 100 - age in equities and the rest in bonds) but the right answer for an individual depends on their ability and their appetite for risk.

Answer 2

Going forward, I am curious how financial advisers calculate an investment mix for a client. Is there a recommended formula that adjusts based on a persons age and financial situation? I'd love to see it.

A general rule of investing is that as you get older, you reduce your market exposure. Traditionally, advisers have used the “100 minus age” rule, which is the percentage of your assets that you should allocate to the market (equities). The older you get, the more you shift toward fixed income, thereby reducing the volatility and risk of your portfolio.

In recent years, many advisers have suggested that due to increased life expectancy as well as the past decade of low rates, this rule of thumb is outdated. In order to avoid running out of assets in one's lifetime, some are now suggesting 110 or even 120 minus your age. This is just a starting point for calculations. Other factors need to be factored in:

Portfolio size Debt Current/future expenses Pension Social Security Other sources of income Gender (women live longer) Risk Tolerance Etc.

There are retirement calculators out there. Each underlying algorithm reflects an opinion and similar to what D. Stanley stated: It's as much of an art as a science. There's no one size fits all answer and multiple evaluations will generate multiple answers, often differing. But despite that, they will provide a blueprint of sorts from which to start from.

There are many financial advisers out there who will provide basic free evaluations - individuals as well as investment banks. I would suggest that you avail yourself of these and use their advice to help advance your learning curve. You might find something that fits into your financial plan. I did, despite being an almost old, retired fart :->)

Answer 3

The answers provided by D Stanley and Bob Baerker are correct from traditional retirement perspective (D Stanly has though hinted at alternate views), I shall try and provide an alternate view.

The primary reason for moving from Stock/Equity based instruments to fixed income as one gets older is to protect against volatility/market risk. In theory, therefore, there is absolutely no requirement for fixed income instruments in ones portfolio if the inherent volatility of Equity can be controlled.(There is however uses of fixed income instruments, more of that below).

If you refer to this D Stanley's post. It is quite evident that if one can wait out a market downturn (which is about 2 yrs. in this case), one can not only recover the capital lost but make quite good returns (more than fixed income instruments). However, this volatility can be controlled to have no impact on your financial situation if a corpus is available that can see you through the volatile period and gets recharged during the high return period.

I shall illustrate with an example. Let us say, you have $100 and have bought an mutual fund, taking a basic inflation rate of say 3%, the money after 1 year needs to grow to at least $103, any growth above that can be taken out for your daily expenses. Now, the investment would lose on some years and you shall not get anything from it and it may take another 2-3 years to recover and again give returns above it's inflation adjusted value. So there is a lean period of 3-4 years.

In the above example, a corpus needs to be present that can take care of expenses for 5 years to act as a buffer as your mutual fund investment undergoes a volatile period.

This is where the fixed income instruments come in, this buffer corpus can be invested in liquid/short term debt, where it itself would gain small interest and provide the backup during lean periods.

The final buffer size and the stock/equity instrument investment size depends on your monthly expenditure expectation.

Finally, the objective is to control the impact of market volatility on your income. It can be done through investing increasingly in fixed income as you grow older or have a strategy like above to control the volatility impact.