I'd add a few things that I've learned over the years:
1) Always be invested in the market. Corollary, don't time the market. This is by far the largest mistake people make.
Investors typically pull money out at the bottom after they've suffered a physiologically devastating loss, like at the end of 2008 and hence they miss the rebound, like 2009-now.
This isn't quite the same but it shows what missing the top 25 days in the market over the past 45 years does to your returns.
If you are an investor you need to be in the market, period.
2) Accept that you will lose money some years. If you are buying index funds then you will get market performance, ex fees. Markets go down sometimes. Stay the course.
3) Don't look every day or you will go nuts.
Keep in mind that the largest draw down (top to bottom) will be larger than what the returns look like if you just look year over year. Ie if you look and see the S&P lost 28% in 2008, understand that if you watched the S&P every day of 2008 then it probably lost more than 28% from its top to its bottom but rebounded slightly at the end of the year to make the year over year loss less than the maximum loss.
4) Have some exposure to outside of the US markets. Consider the scenario of investing all your money in the company you work for. In a rough time for your company you get the double whammy of losing money and possibly your job at the same time.
Similarly to how you are told to not invest all your money in the company you shouldn't invest solely in the country you live in, same principle.
EDIT see child comment, I mangled the English language in point 4
Since that phrase is somewhat ambiguous, let me clarify for anyone who misunderstood it on first reading, like I did. :-)
I'm pretty sure you don't mean "It may be a good idea to invest all your money in the company you work for."
But rather "Consider this very bad thing that may happen if you invest all your money in the company you work for."
Yep, I really mangled that sentence. Sorry to everyone who just invested their life savings into the company they work for.
I guess I really meant...
> Consider the scenario of investing all your money in the company you work for.
This is the part that kills my ability to "set it and forget it". So many things bother me about this. I know I have to do it (because Japan), but how much and on what markets?
* I don't like the idea of investing in emerging markets. Having grown up in one, I know how shady those can be and how cooked the books are. Growth is often an illusion. If an emerging market is "promising", I'd rather wait until it achieves developed status.
* Developed market indexes are dominated by Japanese stocks, which have gone nowhere in almost 3 decades. You have to accept that a good chunk of your money is going into a no-growth sink.
* I don't know what to expect from Europe. Or even Canada for that matter. When I look at those countries from a distance, I see that 1) their large corporations have been established looong ago (i.e. no new ones are created) and 2) heavy taxation and regulations in those countries doesn't seem to leave much room for profits, at least not as much as in the US. I'm probably wrong though, so please educate me.
I know home bias is supposedly wrong, but the American market is well studied, well known, highly liquid, and there's a cultural aspect to its growth in that its part of the general population's mindset to invest in it for long term goals. I don't think that's the case in all (or even most) countries.
Part of me wants to go full jlcollinsnh/Bogle/Buffet, folks who say you don't need international diversification. Another part of me wants to go as blind as possible into it and just invest in a "world index" ETF like ACWI or VT. And yet another part of me wants to do something in between but has no idea what to do :)
Invest into multiple emerging markets, chances are they won't all do bad at the same time, especially if they are in different parts of the globe (take India, Brazil and Indonesia for example), put some into an european index fund, etc.
You seem to be most comfortable with the US market, so the bulk of the assets you decided to invest in equities go there, say 70% and to make things easy put 15% into Europe and 15% into emerging markets. Now you have some diversification, but could still feel comfortable enough to not be worried about your money disappearing over night.
Put your money into it. Walk away.
So what? If your target retirement date was 20+ years in the future, this is arguably the right call. If your retirement date was closer, they still more heavily weighted you toward safer assets.
The fact that they did this before a market crash is irrelevant — nobody can predict these things with any reliability. Not you, not me, not Vanguard.
> They definitely chase performance.
They definitely do not.
> Increased international allocation when they saw it was performing well.
Increased international allocation to track overall market better.
> Besides, they hold international currency-hedged bonds, something that no one seems to be able to come up with a good reason for.
From their website: The fund employs currency hedging strategies to protect against uncertainty in future exchange rates, so investment returns are expected to reflect the underlying performance of international bonds.
Hit this link: http://www.kalzumeus.com/2013/04/24/marketing-for-people-who... and search in the page for Motley Fool.
The only other data point I have to add is that a year or two ago, The Motley Fool published a breathless blog post announcing that 3D printing was about to destroy Chinese manufacturing, and that everyone should invest in companies that make 3D printers or CAD software.
They are a "diversified financial brand" which does a lot of e.g. telling people to get out of credit card debt (a good idea!) and save for retirement (a good idea!). Then they also tell people that "with just a little work, you too can read company numbers and outperform the stock market" (a really bad idea!) and "if you want to do less work, buy our newsletters and we'll give you picks which mumble mumble maybe mumble mumble will make you into Warren Buffet" (a really bad idea!).
Yeah, this is an over-generalization. There are plenty of index funds for European companies at a variety of risk levels, just like in the U.S.
Also, there are worldwide funds too. Capital World Growth and Income Fund (CWGIX)  is one example that covers the U.S., Europe, and Asia. Note that this is a mutual fund, not an index fund.
Edit: Perhaps the downvotes are because this is an actively managed fund. The point of giving the example was trying to counter the specific concern OP stated. For passive, a specific Vanguard fund that's similar, at least the closest I found, is Vanguard Total World Stock Index Fund (VTWSX) . It is very diversified.
(All figures quoted above are "price" and ignore dividends, which is bad but I don't have easy access to dividends-included figures.)
Edit: I think I found one — VTWSX is +35% over the same time period. Accounting for fees vs the managed fund, probably means a better return here.
You can investment just like Buffet if you Berkshire Hathaway Class B (BRKB). Currently ~$145 per share.
I got that from the introduction to an investment book about Buffet.
His successful leveraged investments are analogous to negative expected value bets that people would typically relegate to degenerates.
He advocates indexing for the little people. This has nothing to do with what he did, or does now. (And there's nothing wrong with that)
It's unlikely even Buffet himself could replicate his initial stock picking success over a long period of time and he would be the first to admit that.
Hint: he never sells.
FWIW Vanguard has about 35% allocated to international for me, so it's surprising to see that Bogle wouldn't recommend international exposure.
The risks can be higher but so are the rewards. The most important thing is to not just invest in a market blindly. Try your best to understand that market and keep tabs on that market.
You don't have to diversify for the sake for diversification. You can invest domestically and diversify by industries.
Yes, I've heard that a million times, but that kind of advice presupposes a bull market. What if it's 1967, and you're about to go into a 15 year period of up and down markets, with no real growth in stock prices? And that's before inflation; the market fell substantially during the horrible 70s if measured in real dollars. All kinds of stock enthusiasts (like most folks here) got eaten alive. Pessimism reigned by the early 80s. Most people said "I'll never buy stocks again.".
Ironically, when investors finally capitulated, the great bull market of the 80s and 90s started.
My point is that most people here are mesmerized by that bull market, and by recent gains. But historically the indexes have had huge, long term swings that probably exceed most people's investment horizon.
"Past performance is no guarantee of future results" is not just a legal disclaimer. It's a bitter truth. Our current optimism is strongly colored by recent gains.
What if you had retired in 1929? You would have received nary a return for 25 years.
Sure, indexes average 8 percent or so, over the very long term, but it can be an intolerably long averaging interval.
> What if you had retired in 1929? You would have received nary a return for 25 years.
That just isn't true? You're looking at charts without dividends reinvested. Plug 1929-1950 into https://www.measuringworth.com/datasets/sap/ for example. It had bounced back above 1929 by 1937; never falls below the starting value after 1944.
Social security was signed into law in 1935 (6 years later).
The problem isn't lasting the first 6-15 years (4% rule of thumb = 25x yearly spending; in very low risk cash/bonds obviously that lasts around 25 years), it's having any money left over to last the rest.
And keep in mind, 1929 and ~1965 are the two worst years to retire in in US history.
Definitely this. I personally believe "Always be invested in the market" is very irresponsible advice to give, precisely because it completely ignores this fundamental truth.
Just because markets have averaged a positive return in the past doesn't mean they necessarily will continue to average a positive return in the future. And as the saying goes, the market can remain irrational far longer than you can remain solvent.
That said, I still do invest most of my money in the market, but I don't try to pretend it's anything but a gamble. I've weighed my options, and the upside of investing in the stock market is much higher compared to all my other available options for investment, and I can afford to lose this gamble at this early stage in my life.
But when people ask me for investment advice, I will tell them it's a gamble and let them make that decision for themselves, rather than try to propagate this ridiculous urban myth that the stock market will always somehow eventually end up higher, and add fuel to what has essentially become a massive pyramid scheme.
The easiest way to tell if someone understands financial markets is to find out whether they believe they can time the market. If they believe they can predict the market, they don't know what they are talking about.
[edited - removed ending]
You are astoundingly unlikely to know more about any stock from reading the newspaper, seeing their chart on Google Finance, or consuming their quarterly reports than a team of PhDs who did nothing but study that stock for the last year, and accordingly are vanishingly unlikely to trade stocks in such a fashion that you do better than the market once you account for fees and tax impact.
It gets to why these comment threads can sometimes have people talking past each other. Someone will say "You can't time the market", and mean 'you' in the same way Patrick does, but someone else will come along and think the statement meant "no one can time the market". Then the discussion goes off into a whole rabbit hole about quant hedge funds and the like.
"You are astoundingly unlikely to create something better and more-secure from seeing a blog-post, reading some Wikipedia articles, etc. than a team of PhDs who did nothing but study mathematical theory, cryptography, and code-breaking for the last few years, and accordingly are vanishingly unlikely to create a new scheme which is more secure than existing standards once you account for performance and maintenance."
If you have a reasonable way of distributing software updates, signed-DH with an AES-based AEAD with termination detection for transport authentication, and a signed hash tree for data authentication, is going to be more secure than RANDOM_SECURITY_STANDARD.
Thankfully, there are some good well-written implementations of that (https://www.tarsnap.com/spiped.html, https://nacl.cr.yp.to), but picking a standard randomly will not get you them.
This is the comment equivalent of a loaded question. Or it's like those people who dismiss those arguing against them because of who they are rather than what their argument is.
for example, I'm heavily invested in the market but recent events are leading me to consider halfing my investment rate to be more cautious. I'm not going to take any money out or stop investing but by your def I'm "timing" the market, but really I'm "timing" my life. I don't feel confident that I can afford the risk, and I'm lowering my exposure rate.
The important point I haven't seen mentioned is that the money you put in the market should not be needed for 10 years. Not money you plan to buy a house in about 5 years, or maybe use to get married about 10 years from now. From 1929 to 1933 the DJIA went down 88% before starting to recover. Ten years is really too short a time horizon, you should have a 20 year perspective or longer. If you had invested the day before the 1929 crash and kept your money in the whole time you would not have broken even, adjusting for inflation, until 1957 - 28 years later.
Would I be market timing if instead of moving out of the market to avoid the Trump winning risk, I borrowed money to buy shares in an election market?
If Trump wins, I triple the money I put into election shares but lose in my 401k. If Trump loses, the increase in my 401k will cover my loss in the election market.
Time in the market beats timing the market - the adage is as old as time itself. Not sure that knowing it makes you understand the markets especially well. Similarly, not sure that not knowing it says anything about you either.
I had a friend in college who played World of Warcraft. When the first expansion was announced, he invested $10,000 in Blizzard stock. His reasoning? "It's going to be awesome and sell a lot of copies!"
He didn't understand that the stock price at the time he made the purchase already reflected that information (that there was an expansion coming out soon).
And... just to go a step further. My comment included the word 'easiest' to describe how to find out someone doesn't know what they are talking about. IMO, if someone starts talking about timing the market, I know right away that they do not know what they are talking about.
Other indicators are much harder to diagnose. A self proclaimed market timer is just the easiest to identify.
That's not always the case, just making the point that rebalancing a portfolio is not necessarily the same thing as trying to time a particular market.
You could see cash as a specific kind of market as well with your definition. I'm sure there were time periods when holding cash was your best option.
Rebalancing is not timing the market, unless you're changing your ratios.
Let's say I want 80% equities and 20% cash. The market bombs, and now I have 50% equities and 50% cash. If I thought all the information was already priced into the market, then reallocating to get back to 80/20 makes sense. Not rebalancing would be more like timing the market, because I would be assuming that the current value doesn't represent some "true value" of the market.
> The question still remains: When would you move to other asset classes?
Somewhat regularly, but not constantly because that takes time and has transaction costs. The specific time doesn't matter.
> I'm sure there were time periods when holding cash was your best option.
Definitely, it's just very very hard to identify which periods they are until after they've happened.
Edit: Clarified that both are local.
People also unwittingly imply have actions where, if you asked them, they'd say they couldn't predict the market, but they'll say things like "I'm waiting for the market to cool off"
This. Another way to think of it: if you are out of the market when it goes up by X% that is functionally equivalent to an X% loss, i.e. you have X% less money than you otherwise would have had.
(Well, OK, technically it's equivalent to a loss of X/(1+X) but that's pretty close to X for X<<100%.)
The larger American companies are global companies, so you get that anyway. The proof is look what happens to the US markets when some foreign event happens, like Brexit.
Also, what are your feelings about various robo advisors like Wealthfront and Betterment and the competing products that Schwab and Vanguard have out now?
Say you have Fund A and Fund B set to automatically invest 50/50 your $100 dollar contribution bi-weekly, with a buy commission of $5. You pay buy commissions on fund A and B 4 total times a month, so you've wasted 10% of your monthly investment ability ($200 - $20). In a year that money is $194 at 8%. (This used to be the case with old ShareBuilder/ING/Capital One---not sure about the new-style other brokers)
Consider a monthly payment to Fund A and two weeks later a monthly payment to Fund B. You saved half commission cost of above, and in a year your return is ~$205.
Robo Advisors like Wealthfront are still just advisors, and that means they're just guessing like real-life advisors. And as has been proven time and again, they underperform index funds.
Tax loss harvesting is limited to 3000 per year, but you can carry over until you've exhausted the losses.
Of course TLH is only good if you're in a taxable account with them.
I also don't buy it being easy- particularly with trying to avoid the pitfalls of wash sales and the paperwork to actually claim it.
Typical brokerages can do that too :-).
> rebalance automatically
The value of which is maybe dubious, as pointed out elsewhere in the thread. It doesn't need to be done frequently, if at all, and is pretty trivial with a simple 3-fund portfolio.
> Tax loss harvesting is limited to 3000 per year, but you can carry over until you've exhausted the losses.
Right. But you only get so many working years.
> Of course TLH is only good if you're in a taxable account with them.
> I also don't buy it being easy- particularly with trying to avoid the pitfalls of wash sales and the paperwork to actually claim it.
You need to be aware of how wash sales work even if you use a robo-advisor to do the TLH. You need to be sure you don't have substantially equivalent securities in your IRAs and 401(k), etc. The actual mechanic is pretty easy — sell one index fund (with shares held over 30 days), buy another extremely similar index (but not the exact same index).
As far as the paperwork — it's imported automatically with Turbotax etc and is exactly the same paperwork as is needed for capital gains.
TLH is also only good while you're working. If you have enough TLH saved up to cover the rest of your working years at $3k/year, you can stop paying the robo-advisor premium.
I'm sure there are people that are heavily invested in long duration bonds that do not understand how much interest rate risk they are taking.
Its a little different from a Robo advisor, but I'd probably pay 0.05%+ (5 basis points) annually to know my factor exposures.
I am likely exposed to factors that I am not even aware of.
Hmm. Citation needed. They've barely been letting people invest long enough for that to be "proven" once, let alone "time and again".
I don't believe said evidence exists, here's why.
First, the robo advisors distribute your money directly against and amongst several index funds.
Second, the money-saving benefits robo advisors provide that direct indexing doesn't, like very frequent automatic rebalancing and automated (aggressive) tax-loss harvesting.
Third, the ability to diversify any amount of money. You can put $1k into Wealthfront and diversify across five Vanguard index funds. But directly on Vanguard, this is impossible because the minimum investment in most Vanguard funds is $3k .
With that, take their Total Stock Market Index Fund as an example. If you can only invest $3k in it, your expense ratio is 0.16% . If you can invest $10k in it, your expense ratio is 0.05% . Through Wealthfront, I can hold the VTI ETF at 0.05% expense ratio, which I don't have to pay directly, only indirectly out of the standard Wealthfront fees.
The best possible claim I can imagine then is that for very large accounts, excluding tax-loss harvesting benefits and any benefits of rebalancing, it is cheaper to index invest — for example, if you have a $100k account and can spend less than $225 worth of your time  in the entire year keeping up on it, rebalancing if you wish, etc., then in some cases you could beat the robos. The tradeoff of going direct is arguably not free though. I also don't believe this level of investment applies to most people, at least most Americans.
In fact, for accounts under $10k, the Wealthfront fee is zero. I can't think of a good reason why everyone shouldn't take advantage of that.
Well, they charge additional fees. They have to make that up somewhere or it's the same (but at higher cost) as buying the indices directly.
> very frequent automatic rebalancing
This actually costs money and doesn't improve outcomes. Scroll to "study for the NYTimes on rebalancing" on http://johncbogle.com/wordpress/category/ask-jack/ . Or http://www.morningstar.com/cover/videocenter.aspx?id=615379 .
> automated (aggressive) tax-loss harvesting
Tax-loss harvesting has very limited benefit. Mostly you can offset income. But it's only $3k/year. You can harvest enough losses by hand to easily take the $3,000 deduction too.
> Third, the ability to diversify any amount of money. You can put $1k into Wealthfront and diversify across five Vanguard index funds. But directly on Vanguard, this is impossible because the minimum investment in most Vanguard funds is $3k.
No... you can buy the same Vanguard ETFs with no minimum.
> With that, take their Total Stock Market Index Fund as an example. If you can only invest $3k in it, your expense ratio is 0.16% . If you can invest $10k in it, your expense ratio is 0.05% . Through Wealthfront, I can hold the VTI ETF at 0.05% expense ratio
You can just buy VTI as an individual. You still get the 0.05% rate.
> The best possible claim I can imagine then is that for very large accounts, excluding tax-loss harvesting benefits and any benefits of rebalancing, it is cheaper to index invest — for example, if you have a $100k account and can spend less than $225 worth of your time  in the entire year keeping up on it, rebalancing if you wish, etc., then in some cases you could beat the robos.
Yeah. Reducing expenses is the goal.
I feel like you may have overlooked some of the nuances in my answer, because I've already specifically pointed out how the robo advisors can be cheaper than buying the indexes directly for a lot of people.
If that's what you think, you've missed some of my post :-). Specifically, I said:
> you can buy the same Vanguard ETFs with no minimum.
As an individual you can get 0.05% VTI directly from Vanguard. No $3k minimum (minimums are a mutual fund thing).
>>I stopped putting money into the stock market since a while ago
These two statements are in conflict with one another. You are literally timing the market by not investing anymore. Just invest every month and you will be much better off.
You realize you are trying to time the market, right?
There's a big difference between timing the market and looking at p/e ratios or debt load for stocks (or entire indexes) and deciding that they are way over valued. If you also think bond interest rates are too low likely to climb, hold your cash and come back to pick up stocks when they are cheaper. There's nothing wrong with that strategy as long as you are buying and selling on value and not trying to time a crash. Let the mob chase the yield down the rabbit hole.
If no one did this and everyone was just long everything forever, the market would be immediately broken.
edit: While I think John Bogle is a hero of the investment world with advice that all investors should heed, the Boglehead-Dunning-Kruger-effect can be profoundly annoying. They are a fantastic starting point and they address the most common mistakes, but it's a wee bit more complicated than Bogle's rules if you really want to learn equities and investing.
To conclude, I think it is prudent to review your asset allocation maybe once or twice a year, and shift things around a bit.
I'm glad you don't adhere to the defeatist approach of Efficient Market Hypothesis proponents. Always be in the market, yes. Always follow the market, no.
here's something to think about, and i know i'll take downvotes to hell for all this: if everyone agrees and everyone is investing (for retirement etc) identically (long stocks bonds whatevers), what are the odds it's "cheap" or represents future extraordinary gains?
If I have 99% cash and 1% in VTI for 10 years, am I "always invested in the market" during this time?
It's a whopping 16 page book of plain talk and he made it free on the internet, no strings.  It's the best introduction to planning for retirement, especially for those under 35, I've read so far.
First of all their fees are too high. Wealthfront's 0.25% fee seems rather small and it is smaller than what a lot of human advisers charge, but if you compute it over a lifetime of savings with the negative compounding effect it will cost you a lot.
Imagine you receive some money when you are 20 from a rich uncle and invest it for 40 years using the wealthfront fee structure. After 40 years you will have paid about 10% of your savings in fees. Or, in other words, you will have about 10% more savings if you had taken a couple of hours to sit down and decide which funds to invest in. Keep in mind that the wealthfront fees are in addition of any etf or mutual fund fees you have to pay to get into investment vehicles.
So yeah, compounding interest is a dangerous thing.
There is another problem with roboadvisers -- people put too much trust in them. In our society there is this implicit trust of the computer, probably bred from multiple sci-fi shows with all-wise computers. Well it is a very dangerous thing when it comes to your savings.
You may not be the best investor, but you should take responsibility in your investment choices. You should know what you are investing in and why. Even if the thing you are investing in is a boring simple S&P 500 fund (as it should be for most of you) you should know what it is and why you are investing in it. You shouldn't just blindly follow some algorithm programmed by god-knows who.
If you just want to 'set it and forget it', consider its an approach you're taking with the fruits of decades of your life.
The Betterment site is pretty, which makes me more inclined to put more money into it more often. This is irrational, but for me this makes it worth more than the 0.15% I end up paying them in fees.
I'm less sure about whether TLH is worth the 0.15% fee, though. The premise is that you do some "equivalent" (to you, but not to the IRS) transactions, report them on your tax return, and lower the taxes you pay today ("basis"). In exchange, you would have to pay those taxes later on your investments when you withdraw them. Is this always the right answer (because those later taxes are in compounded-inflation dollars)? What if I think my tax rate now is lower than the tax rate in ten, twenty, fifty years?
That being said, you won't always benefit from it, and there are caveats you should read about. I've decided to take a slightly more hands on but simpler approach, and have moved all of my investments into a simple 4-fund portfolio at Vanguard.
If and only if you would have done about as well as the robo-advisor in those couple of hours. (I'm not saying this would or wouldn't happen, but it's pretty big for an unstated assumption.)
My point is this portfolio distribution stuff is not an exact science and there really isn't a right answer. There are some broad accepted guidelines, but they are rather broad and simple and you definitely do not need computers to follow them.
Should I also be performing the work of checking several times a year if I should be making sales, recording the losses, buying equivalent securities, and bundling that into a form for the IRS?
Ex: Wealthfront's high risk portfolio back in 2013 had significant exposure to commodities -- mainly oil and metals. That sector has done poorly to say the least, and many a retail investor would not have correctly understood what Wealthfront's definition of risk actually meant.
Actually, both account types have the same yearly limit; it's just that the employer can contribute much more than the employee, and when self-employed you can contribute as the employer.
In fact, the difference between SEP IRA and 401k is not the funding limits, but the fact that the SEP IRA allows only employer contributions. You can actually open a "solo 401k" for yourself if you are self-employed, and make both employer and employee contributions. That will let you put more money away for a given income than the SEP IRA, until you make 275k or so at which point you have hit the cap for both (and the cap is the same for both).
Edit: Vanguard has a calculator to show the difference:
Additionally, with a solo 401k plan, the $18k employee contributions can be Roth.
And you think that's problematic? I have relatives telling me that they'll go with X anti-thrombotic therapy because a cousin of the brother of a guy who they met in the supermarket took it 6 years ago and worked wonders for him. I'm a pharmacist and I have rather strong opinions about some drugs over others, but I can take advices from doctors, physicians, nurses or anyone with a minimum degree of knowledge on the topic. Still, many times I have to argue with with relatives, to the point where I get frustrated.
Edit: It's not clear from the essay, but I'm assuming Patrick's 8% rate is not adjusted for inflation (based on his 40k drawdown scenario - the other 3-4% would cover inflation).
On scale, it makes it seem like +3% to +7% real returns is "neutral". This makes it seem like the stock market is sometimes good sometimes bad but overall it may as well be just okay.
On comparisons, it does a huge disservice by not adding a tab showing bond yields and a tab showing cash/treasury yields (which would be dark red across the board except light red around 1930).
I feel these slights make the graphic present stock investing in an unfairly unfavorable light and makes the suboptimal strategy of keeping your money out of the market seem much more favorable than it is.
This single diagram explains the market dynamic year over year in a way I've never seen anywhere else. The 1/3/5/10 yr returns figures you see don't even come close to understanding the nuances of one year over another.
I remember when this diagram was published in 2011 and _still_ refer to it routinely.
This is why you do dollar cost averaging and steadily invest every year, to spread out your investments over multiple years.
Also, there's dollar cost averaging like "I have a lump sum now, but I will invest it slowly over the next 2 years" and there is dollar cost averaging like "I will invest money as it comes in slowly over the next 2 years instead of saving it up and investing it as a lump sum then". The former is the technical definition, but the latter is what most people mean when they use the term informally...
Right now it is at 7.6%. It is not inflation adjusted, so it's lower in real terms. Also, for the great majority of those 20 years, the APY was much lower. And, since most advice says to do some mix of domestic, international, and bonds, most ideal portfolios will have even lower performance.
I know it's just one data point, but one reason this is lower than expected is because people tend to have more money to put into the market when times are good (and the market is high), and less money to put into the market when times are bad (and the market is low). It was true for me in terms of my contribution history, at least.
And if you're concerned about "one data point", I'll give you plenty:
For a 20 year window, it's below 6% inflation adjusted, and close to 8% without taking into account inflation (closer to your 7.6% figure)
US GDP growth has been slowing for decades now. At some point that will be reflected in the markets and the index funds that track them.
(But, yes, I still invest in index funds. I just don't have the same dreamy expectations that many other people seem to have.)
The whole "you'll average 8%" (or 5% or whatever number gets quoted) is an idealized figure assuming you always buy and hold periodically and regularly and never need to stop or withdraw to deal with life's many curveballs.
The first question is: What window are you looking at? For 30 years, it's about 6.8% for the last 30 years (inflation adjusted - close to 10% if you ignore inflation).
I've plotted it for each 30 year period going way back. 6.8% is not high. It's been well over 10% a number of times. I think 7% is a good average.
His figure was from a 10 year window. Unless you plan to retire in that timeframe, I would suggest just looking at a larger window. Less volatility.
Oh, and based on my plots, his 8% looks like it is inflation adjusted.
The problem with looking at extremely long periods of time (i.e., 50 years) is you see these massive events like depressions and the housing crisis. How many of those will happen in the next few decades... who knows?
Maybe we'd be better off to look at median percentages than averages.
If realized rates over the next ~30 years are less than 5%, not only are we as a civilization going to have bigger problems than my retirement, but I don't think much anything will save you regardless of how much you are saving, unless you have a very frugal retirement.
Also, regarding safe withdrawal rates, consider that (depending on the jurisdiction) in retirement you might have to pay taxes on the nominal rates, but then leave enough to compensate for inflation.
Say: 4% nominal, pay 25% taxes, leaves you with 3%, but 2% inflation, so you can safely withdraw only 1%. Thus, conservatively, $1m might give you only 10k a year.
I use  to do most of my predictions. I think you are being way conservative with assuming a 4% withdrawal rate will only give you $10k real dollars on $1m invested, but everyone has different risk tolerances and assumptions :)
Disclaimer: I'm looking primarily at Germany and HK, where growth and equity returns, respectively, have been lacklustre over the last decade. Though, even the S&P 500 has only made 2.5% p.a. since 2000.
I simply cannot fathom why he would state that. I cannot imagine a scenario where my retirement income would (nor should) be as high or higher than my peak earning years.
Typically in retirement you have a home and all sorts of hard goods (clothes, furniture, cars) paid off and thus need less money.
Also note that any increased or decreased "need" doesn't factor in to the calculation.
I see the Roth/Regular as a bet-hedging opportunity - ideally, put some in each type and then you are ensured against either scenario.
>...In 1958, approximately two million filers (4.4% of all taxpayers) earned the $12,000 or more for married couples needed to face marginal rates as high as 30%. These Americans paid about 35% of all income taxes. And now? In 2010, 3.9 million taxpayers (2.75% of all taxpayers) were subjected to rates that were 33% or higher. These Americans—many of whom would hardly call themselves wealthy—reported an adjusted gross income of $209,000 or higher, and they paid 49.7% of all income taxes.
>In contrast, the share of taxes paid by the bottom two-thirds of taxpayers has fallen dramatically over the same period. In 1958, these Americans accounted for 41.3% of adjusted gross income and paid 29% of all federal taxes. By 2010, their share of adjusted gross income had fallen to 22.5%. But their share of taxes paid fell far more dramatically—to 6.7%. The 77% decline represents the single biggest difference in the way the tax burden is shared in this country since the late 1950s.
If the government folks don't pay them, then it's going to basically be Mad Max and your IRA (whatever the type) won't really help you much.
If the government folks do pay them, then the money for that has to come from somewhere. It's very unlikely to come from businesses, because the little ones don't make enough and the big ones pay very bright lawyers and accountants to keep the .gov away (cough Apple cough). So, it's probably going to come from income tax.
Get a Roth.
Put it in the IRA and if things don't go to shit, your money is fine. Don't put it in the IRA and of things go to shit, lose the tax advantage.
Do either and things go to shit, it doesn't matter which you did.
But, if you've already maxed out your other tax-advantaged space, and you have more money to contribute, there is no reason not to put it in a Roth instead of a regular taxable account, assuming you are eligible, because then you can have tax-free growth at least(worth less than tax-free contributions, but still worth a lot).
Roth IRAs make sense if you make too much to contribute to a Traditional IRA with tax advantaged contributions and little enough to still qualify for the Roth.
They also (both traditional and roth) have an advantage over a 401(k): You get to manage the funds any way you want. You also get to contribute even when your employer doesn't have one, you just need income (capital gains don't count, as I understand it, so being semi-retired and living off your earnings does preclude you from contributing).
You're also limited on 401(k) investments to whatever your employer contracted for. Could be shitty, could be stellar, you don't control it.
Like a lot of retirement thinking, it's unsettling to think about the negative scenarios.
On the other hand, saving when you have $150K/year income in order to push your retirement up to $100K/year could make sense.
(All numbers in this example are inflation adjusted to each other)
Your effective tax rate is likely to be much less than your marginal rate.
Also, for anyone interested in financial independence and simple investing with your 401k and IRAs, I'd like to recommend the Stock Series here: http://jlcollinsnh.com/stock-series/
Another one that no one has mentioned: state income tax. I live in CA but would put a >50% chance that I will live in a lower tax state when I retire. Thus, Traditional > Roth.
Me either, unless he assumes:
1) His audience is all tech workers, and
2) all tech workers are making better than $62k (single earner) or
whatever the higher married-jointly exclusion is.
Under what conditions could this occur?
At very roughly $120k-$130k (single earner; I forget the exact figure) you're no longer eligible for Roth IRA contributions. However, you can make non-deductible Traditional IRA contributions and then do a Traditional-to-Roth conversion (not "recharacterization"). This is known as a "Backdoor Roth IRA contribution" and is legal and explained in nauseating detail on the internet.
> Under what conditions could this occur?
If you make more than ~$62k, have an employer 401(k), and contribute the maximum to it, funding a Roth IRA is a good idea.
(Unless you have an existing traditional IRA balance which would make backdoor Roth funding counter-productive due to the pro rata …. blah blah. If you don't have an existing Traditional IRA balance it's not a problem.)
Also an HSA can be used to shelter a bit more income. If you don't consume much health care a HDHP may be the way to go.
There is also the backdoor Roth, but I never wrapped my head around it.
Take a look at any of the Millenials working in any large-city downtown: they spend every single penny they earn, they have no savings; when they get older, either the State will let them starve to death, or taxes will be raised in order to take care of them.
I don't think the former is politically possible, so taxes will have to go up.
Meanwhile, the same spendthrifts are by-and-large refusing to have children early, which means that there will be fewer workers to pay those taxes.
That means that there will be tremendous political pressure to raid 401(k) plans and IRAs. I actually believe it's even odds whether Roths will end up taxed one way or another (perhaps with 'withdrawal fees' or some form of Social Security clawback or something): it'll be too much money for the State to leave alone.
The advantage of a 401K over the Roth is that since both can be raided, at least with the 401K your money is being taxed only on the way out. With the Roth you are being taxed on the way in for sure, and you run the risk of it being taxed on the way out as well.
Judging from the past my guess would be that we wont see something as obvious as a penalty or a fee. Instead what you may see is a more aggressive required minimum distribution schedule. Perhaps you could see the date of penalty free withdrawal pushed back from 59.5 to 65 or 67 years of age. Means testing of social security benefits has been mentioned before. If that gets put in place, and you fail the means test for social security, they will have effectively taxed you more your entire working life.
Or we could just continue doing what we are currently, and just keep piling up the debt :) No tax increase or Roth/401k raids needed.
Don't forget the more politically expedient (and in my view most likely) choice: Print money to pay for it, causing inflation, which is essentially a silent tax on everyone with money.
This is an assumption I'm working under, but I've thought about it for a more normal case as well.
Still, the usual advice for saving for a normal retirement is 10%-15%, and you only have to break $185k before a 401(k) doesn't cover even the low end of that.
Also, if you're making that much, even if you want to retire early, the normal % rules of thumb don't necessarily apply, assuming you want to live a normal middle-class life in retirement. You should run the numbers on http://firecalc.com, you will find if you live frugally making that much and contribute the max you can easily retire in under 20 years with a >90% chance of success. If you want to retire to the high life you will either have to contribute more than normal(and invest well/be lucky) or work longer, no matter your income.
Edit: I will say that there is a potentially significant disadvantage, especially for high earners, in having a lot of your net worth tied up in a 401k. That is required minimum distributions, essentially forcing you to take out a certain percentage of your account balance when you reach certain age thresholds. You can somewhat easily get around this by rolling over into a Roth IRA(backdoor Roth), but that could offset many of the tax advantages of the 401k in the first place if you have significant traditional IRA holdings. This is mostly deleterious if you are planning on bequeathing an estate in a tax-advantaged way, but you may be able to get around it with a irrevocable trust. Consult a fiduciary, this is not financial advice.
I look at it as diversifying against tax law going crazy though, siNce so much of my retirement income is in 401k and pretax. Also the limits are a third of 401k, so it's only a quarter of retirement savings, and principal can be pulled out if needed.
I can imagine wealth taxes at some point ('those fat cats never paid taxes on all that money!').
Frankly, I don't think it's possible to be too pessimistic about the future.
Because the entire thesis of this thread is that it is better to contribute to a 401k and other pretax accounts before contributing to a Roth under nearly all circumstances(other than at the beginning of your career) that don't involve massive tax raises in the future.
Non-deductible IRA actually gets a worse tax treatment than an ordinary taxable account, due to the long-term capital gains rate being lower than the income tax rate.
> "...you can withdraw retirement account money early to pay for education expenses, fund a first-time home purchase, ..."