401k and 403b – Page 2 – The Stocky Fox

I screwed myself by rolling over my 401k

March 9, 2016March 8, 2016 Stocky Leave a comment

Kind of, but not really. I wanted to put a dramatic headline up to see if that would drive more traffic. However, I did lose a little bit of money by rolling over my 401k from Medtronic into my IRA with Vanguard. Here’s my story:

As you know, I left my job at Medtronic a while back. Whenever you leave a job, there’s actually a lot of work involved with your finances. You have to move them from the accounts set up by your company, to your own individual accounts. Best case is it’s a pain in the butt; worst case is you can forget about some of it and lose it forever. So it’s an important process.

So when I left Medtronic I knew I had to take my 401k account and roll it over into an IRA. But there wasn’t a lot of urgency because Medtronic had their 401k at Vanguard, and all our other accounts are at Vanguard, so it seemed fine. But then the Medtronic/Covidien merger happened, and as part of that, Medtronic switched from Vanguard to Aon Hewitt. I wanted to keep all my money in one place for convenience sake, so I called Aon and initiated the rollover.

For those who have never done it, it’s a pretty simple process. You set up an IRA account where you want the money to go (Vanguard in my case). They’ll ask you how you want to fund the IRA and you click on a choice that says something like “Rollover”. Then you call up the place where you’re money is at (Aon in this case) and start the process. Usually they’ll send you a check which YOU DO NOT CASH, but instead just send it on to Vanguard. Overall the process takes about two weeks.

But that two weeks is what screwed me a little bit. During those two weeks your money is not in the market. As you know from many posts I have done, the stock market is really unpredictable in the short-term, so it’s impossible to time the rollover process to your advantage. Ideally, that two week process would coincide with a brief downturn in the market. Conversely, you hope that two week period isn’t when the market stages a blazing recovery.

Based on the title of this post, you can probably guess what the case was for me. As we know, the first few weeks of the year were really bad for stocks, and then they started a slow recovery. If I could predict the future, that would have been the time to do my rollover, at the beginning of the year right before stocks fell 10% over the course of a couple weeks. Of course, if I could predict the future, I would own my own island in the Caribbean.

I took the plunge in mid-February, and as you can see, stocks started inching up. It was a perverse feeling: of course I like when stocks go up because we have so much invested in stocks. But on the other hand, I felt that part of my portfolio was missing out on those gains. Following the stock market too closely can really mess with your head. Anyway, after a week, I got my check from Aon, which I promptly sent to Vanguard. In that week, stocks were up about 0.8%. My 401k from Aon was worth about $140,000, so missing out on that 0.8% gain cost me about $1100.

Once I put the check in the mail to Vanguard, the investing gods decided I needed to be further humbled, so in the next week stocks went on a major tear, rising about 3.2%. Of all the times, why then? My being out of the market for that week cost me another $4400.

Roll over IRA

Add that up and you’re talking a decent chunk of change. My timing for doing the rollover couldn’t have been worse, and in the end I missed out on about $5500 in market gains. That sucks.

But you win some and you lose some. I am sure that I have come out ahead some of the other times I’ve transferred accounts, but as Matt Damon’s character said in Rounders: you tend to remember your spectacular loses more than your amazing wins. Just human nature I guess.

That said, there’s definitely a lesson there, which is you need to stay in the market. As we have discussed ad naseum, the market is very unpredictable in the short term often times with wild swings. But over the long term it has a relentless upward march. I had to get out of the market for a pretty unavoidable reason, so maybe I get a pass. But what about those people who got spooked by the January plunge and then missed out on the February recovery? They got crushed and could have really hurt their financial plan.

So there you go. I hope you were entertained by my misfortune.

Biggest investing mistake—Forgotten money

February 3, 2016February 2, 2016 Stocky 3 Comments

On this blog we talk about a lot of ways to scrape out a little bit higher return for your investments, or shave off some of the expenses. That one or two percent may not seem like a lot, but over time 1% can really add up.

However, what if I told you there was a mistake a lot of people make that doesn’t cost them one or two percent of their investment, but costs the entire amount of their investment? What if I told you Stocky Fox himself came really close to making this mistake?

Forgetting your money. It seems absurd that you would ever “forget” about the money you have worked so hard to save, yet this happens to people all the time, maybe it’s happened to you and you didn’t even realize it (that’s what “forget” means), and it almost happened to Stocky.

My close call

As you know I left my job at Medtronic a while back. Like so many, much of my nestegg was tied up there—my 401k, Medtronic stock options I had received, Medtronic stock I had purchased at a discount, money I had set aside for a flex spending account. When you switch jobs you’re especially vulnerable to “forgetting” about your money because you have to move it (sooner or later) to a place that isn’t dependent upon your former employer. Probably similar to when your packing up all your stuff after a hotel stay, you’ll probably get most of it and certainly the most important stuff, but you might forget something that isn’t top of mind.

To make matters worse for me, Medtronic just merged with Covidien so the companies that held all the accounts changed. Our 401k was with Vanguard but got switched to Aon Hewitt; our stock purchase account went from Wells Fargo to Fidelity; our stock options went from Schwab to Prudential (I think it was Prudential).

So, if you use that hotel analogy, I thought I got all my stuff, but if I did forget anything it would be nearly impossible to find it because they kind of changed the location of the hotel after I checked out. But I wasn’t really worried because I tend to be on top of this stuff. I am Stocky Fox after all.

Fast forward and the Fox family moves to North Carolina. Because we bought our NC house before our California house had sold we had to scrape together a lot of money for the down payment. That worked out well because when I quit my job all my stock options expired, so I had to cash those out anyway. We just used that money to go to the down payment. Simple story right? All well and good.

As it turns out, I did exercise all those stock options, but didn’t get the check for all of them. For reasons that aren’t worth diving in to, the money for my most recent options couldn’t be sent to me for a while longer. I didn’t realize that, and I thought I had gotten all the money. Wrong. There was still about $8000 of the Fox family’s hard earned money sitting at Schwab that I had stupidly forgotten. But then, because of the merger, that money I didn’t know about got moved to Fidelity. So I had money I didn’t know about in a place I didn’t know existed.

Luckily, Foxy Lady’s 401k is with Fidelity so I log in there every once in a while to check on that. One time when I was at the Fidelity website, just on a wild lark, I put in my old username and password (my 401k from another employer was with Fidelity). To my shock, there was $8000 in my account. It took a little bit of digging and calling them to figure it all out, but that was the money I had thought I had taken (just like the shirt hanging in the closet of the hotel you thought you packed).

Since then I have double and triple-checked all the old accounts and called the new places that have the accounts and I’m pretty sure that I haven’t left any money behind. But I was pretty sure I had done that before, so I don’t know how “comfortable” I should be.

How this might affect you?

Maybe the details are different, but this same story happens ALL THE TIME. I help out a lot of people with their finances, and it’s not uncommon for people to say after they’ve shown me all their accounts: “That’s pretty much it. But you know what? I think I had something with someone from that job three jobs ago.”

Maybe it’s not a lot of money (if it was a lot of money, you’d probably remember it), but it still adds up. That $8000 for me will probably grow to $50,000 by the time I’m 65.

Obviously it’s not easy to remember things you have forgotten; that’s what the word “forget” means. But if you know this can happen, you can put your guard up and maybe be a little more diligent. A few of the common ways this can happen, based on my own experience and that of people I work with, are:

401k from previous jobs—this is probably the single most common example. A good practice is to know where all your money is. When you switch jobs, this is a time when you really can take it all with you.
Other investment accounts with your job—like my situation, you might have money in other places with your employer.
Life insurance—Foxy Lady has a policy that her dad, Papa Ocelot, set up for her when she was a little vixen. It has a cash value and every year we get a statement on it, and every year we don’t do anything with it and the cash value steadily decreases.
Money when you move—If you move you have about a thousand balls in the air. Often times you might have a deposit with a utility or you have prepaid for a year with your insurance or something else. That money is yours but you might have to put a little effort in to get it. Otherwise, it will just sit like an orphan is some abandoned account.

The point here is obvious. We all work hard to earn money, and even harder to save it. And of course, no one intends to do this. But so many things can hit you at once and even someone who is really on top of their finances (as I believe I am) can let something fall through the cracks. But this is the easiest money you’ll ever make.

Do yourself a favor tonight. Take 15 minutes to go back in your head and try to remember all the places you’ve saved money—that 401k account, those savings bonds your late uncle gave you as a kid, what ever. Can you account for it all?

The power of a single percentage

February 23, 2015August 25, 2015 Stocky 6 Comments

“How can something so small be so impressive?” –Belinda Heggen

1% doesn’t seem like a lot. It’s the extra sales tax my city adds, hoping I don’t notice it. It’s the maximum amount of gross stuff food companies can put in packaged food without having to tell us (I don’t know it that’s true or not). But in investing 1%, while so easy to overlook, can make a huge difference. Here we’re going to find out how we can get that 1% to help us.

Let’s go back to my neighbors, Mr and Mrs Grizzly. Each year they will save $10,000, investing it in a stock index mutual fund with an expected annual return of 6%. After 30 years, they expect to have $790,581 saved (good time for the disclaimer that I am not predicting future stock performance, just giving an example), a tidy little sum to help see them through their golden years.

However, Mrs Grizzly starts playing with her spreadsheet and changes the annual return from 6% to 7% just to see what happens. She’s astounded to see that the $790,581 that she gets with a 6% return balloons to $944,608 if she assumes a 7% return; that increase in the annual return of 1% led to an increase in her nest egg of 19%. Tempting fate she sees what happens with an 8% return: $1,132,832. She’s a millionaire now. Cranking the return up to 9% made her nest egg $1,363,075; just increasing her return 3% nearly doubles how much she and Mr Grizzly will have to retire on. Ladies and gentlemen, welcome to the power of compound interest!!!

The point here is that a seemingly small 1% change in your investment return can make a huge difference over time. By tailoring your investment strategies to collect as many “1% coupons” as possible, you can substantially increase, even double, the value of your nest egg.

So how do we get those higher returns? Most people will default to higher stock returns: “It’s a no-brainer. Instead of investing in the stocks and mutual funds that return 6%, let’s invest in the ones that return 7%.” Unfortunately, after reading A Random Walk Down Wall Street we know this isn’t so easy. For any given level of risk, our investment return is probably going to be what it will be.

Now that changing the actual investment return is out, what are our options? Fortunately there are a lot of other things that affect our total return beyond just what our investments give us. We’ll dive into each one of these with its own blog post, but a few to think about at a high level are:

Mutual fund management fees: Each year mutual funds charge between 0.05% all the way up to 1.50% or more for management fees. Going from high-cost mutual funds to low-cost funds can easily get us a 1% coupon.
Financial planner fees: There are a lot of people out there who are more than willing to tell you how to invest your money for a small fee. Except that fee doesn’t tend to be all that small: about 1-2% of your total assets. Do-it-yourself investing can absolutely give you that 1% coupon, and the results you produce will probably be similar to those your investment adviser would.
Being smart with taxes: You know Uncle Sam is going to take his cut. However, you can delay when he takes his share with IRAs, 401k’s, etc. This allows you to keep the money longer, and it allows to you be taxed on the money later in your life when you will probably be in a lower tax bracket. Being smart with your taxes can easily get you a 1% coupon.
Take the “free money” offered to you: Many of us work for companies that match 401k contributions. Except they only give you the extra money if you invest in your 401k. So at least putting in up the minimum amount of get the match can absolutely give you one or two 1% coupons.
Proper asset allocation: We all know that some of your investments should be in higher return, riskier investments like stocks and some should be in lower return, less risky investments like bonds. Properly assessing your portfolio to know how much you already have in less risky investments (especially things like pensions, Social Security, your home equity, etc.), can allow you to safely put more money in investments like stocks. Over the long term, this could easily increase your return each year and get you a 1% coupon.
Fully investing: So many people I talk to have $10,000 or $20,000 or $50,000 in their checking account that they’re “just waiting to figure out what to do with it.” These are certainly Champagne problems, but they are also fertile ground to find 1% coupons. Just taking that money and putting it in a bond fund instead of a checking or money market account could easily give that extra 1% or more; investing in a stock fund will provide even greater returns over the long run.

Those are just a few examples of how you can squeeze an extra 1% or more from your investment returns. You’ll notice that none of those strategies include “outsmart Wall Street and pick the stocks that are going to do the best.” I’m not that smart; I wish I was because then the Fox family would own its own island in the Caribbean next to Johnny Depp’s island. These are all really simple strategies that anyone can do, and each of which takes less than a couple hours to set up, and can lead to hundreds of thousands of dollars over your investing lifetime. The Fox family has benefited by these little strategies probably to the tune of 4-5% extra return each year over what seems typical among your average American investor, and that has equated to hundreds of thousands of dollars.

So here’s the bottom line: As you read this blog, we’ll constantly be finding “extra 1% coupons” that you can redeem to increase your overall investment returns. As Mrs Grizzly showed, even one of those can add $150k to your nest egg. If you can gather two or three or even more, you can double your nest egg.

The tax man cometh

February 16, 2015August 16, 2017 Stocky 2 Comments

“In this world nothing can be said to be certain, except death and taxes” –Benjamin Franklin

I love this woodcut from the 1600s. I imagine the artist drew it so the skeleton’s hand is asking for the guy’s life, but it kind of looks like he has his hand out asking for money like he’s collecting taxes. Either way, if you’re death or the tax man, you probably aren’t too popular.

Obviously taxes are important when you’re thinking about investments and your retirement. Uncle Sam (for all you foreign readers, what is the name of the personified tax collector in your country?) is definitely going to take his share of your earnings and investments. Given the progressive nature of most countries’ tax codes, as your nest-egg gets larger and larger, they take a bigger percentage, so that raises the stakes.

The government has built the tax code to offer huge tax breaks to people saving for retirement, particularly allowing people to defer taxes from their earning years to their retirement years. That’s really all that accounts like 401k’s and IRAs are doing, taking money you earn when your income is high and allowing you to pay taxes on it when your income is low. It may not seem like a big deal at first but suffice it to say, optimally managing your tax situation can be the difference of hundreds of thousands of dollars. As always, it’s important to remember that I’m not a tax expert; also I’ll be making assumptions on future stock returns which in no way guarantee that is what will actually happen in real life.

Working tax rate versus retirement tax rate

US tax rates go up pretty quickly the more money you make. So when you’re in your prime earning years, that is when your tax rate is going to be the highest. Take my neighbors Mr and Mrs Grizzly as an example. They both work and have a combined income of $150,000. Throw in a couple assumptions like they have two cubs, a mortgage, and live in the great state of California, and they are paying a total of about $41,000 in taxes, about 27% (there’s a great website that I used for these estimates). Look a little deeper and their marginal tax rate is 43%; that means if they earned one more dollar they would pay $0.43 in taxes, and conversely if they lowered their income by one dollar they would save $0.43 in taxes. Wow!!! That’s a lot in taxes.

Now let’s fast forward and think of Mr and Mrs Grizzly in retirement. Their house is paid off and they don’t have to save for their cubs’ educations, so what they need to support their retirement lifestyle is $80,000 (believe me, I will have many future posts dedicated to estimating how much someone needs per year in retirement, but for now let’s just take the $80k on faith). Each year they tap into their savings and the $80,000 breaks down into three buckets: $20,000 is interest and dividends; $30,000 is long-term capital gains on the profits from their investments over the years; and $30,000 is the basis, the original money they invested which doesn’t get taxed. Run your tax calculator again and they’re paying a measly $1,200 in taxes!!! Read that again; it’s not a misprint. That’s only 2% compared to the 27% they were paying while they were working. And their marginal tax rate is 4% in retirement instead of 43% while they were working.

That, my friends, is some powerful stuff!!! Now, how do Mr and Mrs Grizzly translate that into cash money?

The value of deferring taxes

During their working years, Mr and Mrs Grizzly set up their budget to save $1000 per month. Because they are avid readers of the Stocky Fox, they know they should save that through their 401k’s (in this unfortunate example, let’s assume their cheapskate company doesn’t offer any matching). In a year they will have saved $12,000 but since 401k’s are tax deferred they don’t pay taxes on that money, saving themselves $5160 in taxes (remember, their marginal tax rate is 43%). Nearly $5200!!! That’s some serious honey comb. They do that each year and after 30 years (let’s assume a 2% dividend and a 5% stock increase), and they have a nice little honey pot of $1.12 million for retirement. They’ll withdraw their $80,000 per year and pay the lower tax rate on it, and life is good.

The Grizzleys are sitting pretty, but what would happen if didn’t use their 401k to defer taxes and instead invested their money in a normal brokerage account? Each year, they’d pay the $5200 in taxes but then they would also have to pay taxes on the dividends of their investments at about a 33% marginal tax rate (special thanks to my ChicagoBooth classmate, Rich, for correcting me on this). If you assume the same investments as we did above, 2% dividends and 5% stock increase, after 30 years they would have $815k. That’s nothing to sneeze at, but that’s about $300k less than what they had with their 401k. Those numbers seem crazy, but that’s the power of tax deferral.

So the lesson is that using tax deferred accounts offers a really powerful way to accelerate the growth of your nest-egg by cutting out the tax man (in a totally legal way, of course).

How to get started saving for retirement

February 12, 2015August 25, 2015 Stocky Leave a comment

So many people I talk to love the idea of investing for retirement and know they need to be doing it, but they just don’t know how to start the journey. As a result, they don’t do anything, months and then years go by and they’re still at square one, but now they’re pissed because they missed out on the red-hot stock market that increased 50% over the past few years. So here is what I would do in order of “Stockiness” (stockiness is a word I just made up that loosely translates to investing wisely).

401k or 403b

If you work for a company that offers a 401k or a 403b, that is probably the best and easiest place to start investing. First, most companies have it set up so it’s pretty easy to sign up and get started. Also, since they deduct the money out of your paycheck, it might be easier for some people to save the money “without having to do anything”. Plus there’s the benefit that most of these plans don’t have any minimum amounts you have to start an account with, so you can sign up, have then deduct your 4% or 10% or whatever, and you’re set.

Of course we’ve saved the best for last—there are two MAJOR advantages of 401k and 403b accounts that really help you boost your nestegg. First, both are tax-deferred (much more on this in a later post) which means that you don’t get taxed on your contributions. So when you put $10,000 into your 401k this year, you don’t pay taxes on that money; had you not used your 401k then you would be taxed at normal income rates which could go all the way up to 40% or even higher, depending on what your situation is—that’s $4000 right there. Certainly, you’ll have to pay taxes when you withdraw the money in retirement but it’s pretty likely you’ll be paying a much lower tax rate then, compared to the tax rate you’re paying while you’re working.

The other MAJOR advantage of these accounts is that most companies offer some type of matching. It’s typically something like they will match $0.50 for every dollar you put into your 401k up to 6% of your salary. Every company is different on their match but there is one thing they all have in common—they’re giving you free money if you’re willing to take it. Like so many things in investing, over time this matching can add up to a lot— tens or even hundreds of thousands of dollars for this little jewel.

As with all things, if it seems too good to be true, you should probably read the fine print. There are a lot of rules associated with 401k and 403b accounts (as I said in the disclaimer, I’m not an expert here). The big one is when you can withdraw the money. The government allows those great tax advantages at the cost of limiting your ability to get at the money; the idea is to have you save that money for your retirement, not your next car or next Berkin handbag (which can cost as much as a car—totally blew me away when Foxy Lady told me that). If you’re in a pinch you can get the money sooner, but it is a major pain in the butt, and often times there are penalties. So the general rule is: put money in your 401k or 403b that you won’t need until your late 50s.

Individual Retirement Accounts (IRAs)

If your job doesn’t offer a 401k or 403b, the next best thing is probably an IRA. They are similar to 401k accounts in that they have tax advantages that can really add up over time, so that is one of the MAJOR advantages. Unfortunately, they don’t have the matching feature which is a bummer. Also, similar to 401k and 403b accounts, these are meant for retirement savings (and have similar penalties for early withdrawal) so it’s best to put money here that you don’t plan on needing until your 50s or 60s.

Unlike 401k and 403b accounts, you have to set these up on your own. It’s not difficult, but it certainly isn’t as easy as if you just check a box at work. The first thing you’ll need to do is pick between a Roth IRA or a traditional IRA. There’s a ton of debate on which is better, but as a general rule I would go with a traditional IRA. Ironically, when I made that decision for myself 15 years ago I went with a Roth IRA and I think I made the wrong decision.

Then you’ll need to set up an account with Vanguard or Fidelity or one of a hundred other firms. Another unfortunate feature of IRAs compared to 401k accounts is that they tend to have a minimum amount required to open an account. For Vanguard it tends to be about $3000, so that may take a little while to gather before you can get started, but it’s still definitely worth the effort.

But there is a nice advantage that IRAs have over 401k accounts—you have many more investment options. With a 401k you are limited to the mutual funds that the company has set up. My experience with 401k accounts is that you have a good variety—bond funds, domestic stock funds, international stock funds, target retirement funds—but you may only have 10 or so choices. With an IRA you can choose from almost any mutual fund there is (just to put that in perspective, Vanguard has 100 funds to choose from).

Brokerage account

If neither of the above options work for you (and that would seem really odd that they wouldn’t, but I guess you have your reasons), then you can open a regular brokerage account with Vanguard or Fidelity or others. Here you could invest in all the same mutual funds that are available to you with IRA accounts.

As you’d expect, the major drawback on these is that they don’t have the tax advantages of the 401k, 403b, or IRA accounts and that can be a pretty huge deal. On the other hand, they do not have any of the penalties associated with early withdraws, so that might be something attractive depending on what you have on the time horizon.

So there you go. Investing is a long journey, but as some poet who’s been deal a long time said, “Every journey begins with a first step.” So the first step is opening an account so you can start investing.

How did you get started investing? We’d love to hear your story.