Finance 101: April 2024
In April the financial advisors at Ruedi Wealth Management wrote five more columns for The News-Gazette’s business extra section. Make sure to look for them every Saturday in the weekend edition of the paper, but in case you missed any in April all five are below.
Can a 401(k) Make You Wealthy?
Paul R. Ruedi, CFP®
A 401(k) is a magnificent savings tool. Being able to save and invest in a tax-advantaged way can really help people supercharge their savings and increase their wealth. But savers are limited in their use of this tool, which left me wondering, can a 401(k) by itself make you wealthy?
I suppose we would first have to start by defining what “wealthy” is. According to Charles Schwab’s 2023 Modern Wealth survey, the typical American puts that number at around $2.2 million of net worth. Could a person maxing out a 401(k) reasonably accumulate that level of wealth?
To test this, I decided to work through a simple example of a saver who contributes the maximum amount to a 401(k) which for this year is $23,000. That saver also receives a 4% company match on $100,000 of income, for a total savings of $27,000 per year.
The savings are invested at the end of each month in a 100% stock portfolio, which returns an inflation-adjusted 7%. It would take that person 27 years and 4 months to accumulate $2.2 million in today’s dollars, and it is only possible due to the early contributions having so long to compound.
Now suppose a couple did the same thing, and both people save the same amount as the person above, putting their annual savings at $54,000. It would take that couple 19 years and 4 months to accumulate $2.2 million in today’s dollars in their 401(k)s. Once again, the majority of that balance is made up of the compound growth from early contributions.
Though $2.2 million is an exciting amount to think about, the fact that it requires decades of saving to get there shows a 401(k) is by no means a get rich quick option. The example even assumes a person maxes out annual contributions, receives a company match, and receives a healthy return from an aggressively-invested 100% stock portfolio, which may not happen.
Though this was an oversimplified example, the math makes it clear that in order to build material wealth within a 401(k) you must start early and invest aggressively. Sure, the ability to make catch-up contributions of $7,500 once a person turns 50 provides some help, but the real magic is in those early contributions.
If you want to build significant wealth in a 401(k) you cannot delay. Start saving as much as possible as soon as you can, ideally as part of a comprehensive retirement plan. If you aren’t sure how to do that yourself, you may want to consider working with a retirement planner.
Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
Accumulation is Easy, Decumulation is Hard
Paul Ruedi
Despite all the moving pieces and factors that need to be considered to successfully fund a retirement, retirement planning can be broken down into two stages. The first is what is called the accumulation stage – when people are working, saving, and accumulating assets to fund retirement.
The second stage is called the decumulation stage – when retirees take the assets they have and start distributing from them to fund their ongoing lifestyle expenses. Though both stages involve their own challenges, the decumulation phase of retirement planning is certainly much more challenging.
Though finding money to save in a rising cost world can be challenging, the accumulation phase of planning for retirement is fairly simple from a technical standpoint. A paycheck comes in, some of it gets transferred to a 401(k), IRA, or brokerage account, where it is then invested.
There are really only a few key decisions in the accumulation phase: how much to save, where to save it, and how to invest it. These are more or less set it and forget it decisions – once they have been made and everything is set up, there really isn’t much ongoing work to be done.
A do-it-yourselfer may get through the accumulation phase of retirement planning without any problems. But when you get to the decumulation phase, things get complicated. All of a sudden you are a retiree with no regular paycheck coming in and you need a certain amount to spend each month from your assets. But where exactly is that money going to come from?
In the decumulation stage you now have to choose which accounts to withdraw from and which particular investments to sell to fund that withdrawal. This has to be done regularly, and these decisions are not simple, one-factor problems.
These decisions should be made considering the tax impact (both on this year and in the future), the targeted portfolio allocation, and long-term retirement goals. With no paycheck coming in, each financial decision feels like it is much higher stakes, which can weigh on people emotionally.
It is for this reason that even the most ambitious financial do-it-yourselfers often throw up their hands and seek out professional help when it comes to the decumulation phase of retirement planning. If you aren’t sure if you have the ability to make all these decisions yourself, or simply don’t want to spend your retirement worrying about complicated portfolio management decisions, I’d highly recommend you consider working with a retirement planner.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Waiting for a Market Drop
Paul Ruedi
Investors in a stock market that rises over time face a unique emotional hurdle: you almost always wish you had invested in the past when prices were lower. People with a lump sum that needs to be invested often find themselves waiting on the sidelines, wishing they could go back in time and purchase at lower prices.
We can’t go back in time, so investors often try to think of another route to lower prices: by waiting for a significant temporary decline to show up before investing. However, there are a couple of problems with this strategy.
The first is that those who wait for the perfect moment to invest, may wait forever. I’ve mentioned before that the average intra-year decline is around 15%, and there is an intuitive draw for investors to simply wait for a dip like this to occur before investing. But there is no guarantee that a decline of this magnitude is going to show up in the near future.
Even if it does show up, this 15% decline may arrive after the market has already increased by 20% or more. In that case, investors would be better off investing today than they would be waiting and attempting to perfectly time that temporary decline.
If the perfect opportunity to invest at lower prices does come along, it will be harder to jump on than most people think. When that golden 20% decline an investor was waiting for shows up, it will be very easy to get concerned the stock market will fall even further. It will be extremely tempting to think the market is going to fall another 10%, so you should probably just wait to purchase then. This will often cause that golden opportunity to slip away while people wait for something even more perfect.
Fortunately, you don’t have to time the market perfectly to have a good investing experience. When you are investing in an asset class that will double multiple times over the decades, whether you purchase at a price that is 15% higher or lower becomes very insignificant.
People who need to invest a lump sum in the stock market should either invest it all today, or commit to investing small increments over time if they can’t handle investing all at once emotionally. If you aren’t capable of doing that yourself, you may want to talk to a financial advisor.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
The Return of Bonds
Paul Ruedi
As a result of the Federal Reserve raising interest rates in its fight against inflation, bonds are producing what feel like substantial yields for investors for the first time in years. Seeing the bond portion of their portfolios produce higher yields feels good to investors intuitively. But bond investors are in the same place they have always been: receiving little to no return net of inflation and taxes.
The current yield on the 10-year treasury bond is around 4.6%. But a person will have to pay taxes on that return, and if a person is in the 22% tax bracket, it would bring their after-tax rate of return on a 10-year treasury down to only 3.59%. The most recent CPI reading showed inflation running at 3.5%, and though that is a backward-looking measure that we can’t be certain will continue, it can serve as a guideline for inflation expectations.
The inflation number and after-tax return number above are so close that even if all interest payments are retained, the bond investor ends up roughly in the same place they were before in terms of purchasing power due to inflation and taxes. People in higher tax brackets are even less likely to keep pace with inflation due to higher taxes taking an even bigger bite out of their returns.
This is nothing unusual. Though the variability in bond returns and inflation cause real bond returns to fluctuate, in general, the inflation-adjusted, after-tax return for bond investors will be close to 0. A bond portfolio may slightly outpace inflation – but only if you reinvest the interest payments. If a retiree, for example, spends the interest their bond portfolio produces, the purchasing power of their principal decreases over time. This means the purchasing power of future interest payments decreases over time as well.
This can ultimately become a financial death by 1,000 papercuts, which is why holding too much of an investment portfolio in bonds is a risk to retirees who need to fund their lifestyles in a rising-cost world. This is why I always suggest retirees hold at least a portion of their wealth in the great companies of America and the world (stocks). But there needs to be a balance, and retirees should have some bonds to provide stability in their investment portfolios. If you aren’t sure if you are holding the right amount of bonds in your portfolio, you may want to talk to a financial advisor.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
4 Years of Columns
Paul R. Ruedi, CFP®
This month marks four years since we began writing these weekly columns in April of 2020. At the end of that month, the S&P 500 index closed at 2,912.43. Hovering around 5,000 these days, the S&P 500 is over 70% higher. But if those four years seemed like an ideal time to be an investor, think again.
We started writing these columns in the very early stages of the pandemic. Those were the days everyone was constantly looking at the Johns Hopkins chart of new Covid cases and deaths across the country. People were buying up all the toilet paper and staying completely isolated to “flatten the curve.” It was a terrifying time in general, and even more so for investors. The economy was essentially shut down and it wasn’t clear when things would return to normal, if ever.
At that time the S&P 500 was hovering below 3,000. Having bounced off the pandemic lows extremely quickly, it was still right up against bear market territory. People weren’t exactly shouting from the rooftops that this was a buying opportunity. More were worried that the other shoe was going to drop.
Then seemingly out of nowhere, the S&P 500 shot back up to end 2020 with double digit returns. 2021 was even better, with returns of over 26%. This unexpected performance really shocked people, but just when people were starting to expect this performance to continue, the party came to an end in 2022 when the stock market dropped by close to 20%. If that wasn’t bad enough, 2022 was also the worst year for bonds in history.
It would have been very easy to become pessimistic at that time. After a wave of interest rate increases, persistent inflation, and other headwinds, 2023 didn’t seem like a good year to be an investor. But investors who stuck with their investments were treated to another year of strong returns in 2023 when the S&P 500 increased over 24%.
What will the next four years hold? Nobody can predict. I can’t rule out performance like we saw over the past years, but I wouldn’t bank on it either. Past performance is not an indicator of future results. Will there be plenty of crises both large and small ready to scare investors out of their investment portfolios? Certainly. The key to success in investing is holding on through the tough times to reap the returns we have received over the past four years. That will never change.
Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.