Personal Finance

Case Study (6):

Long Term Investments

Compile an accurate list of all of your current long term investments. Explain the advantages of each (like matching contributions to 401plans). Now calculate the balance at age 65 assuming no changes in the amount you currently set aside. This site can help:

http://www.finance.cch.com/tools/calcs.asp#DZ06

How much is it and is it enough to retire on? What changes do you plan on making that will help you reach your goal?

Now look at other options that you may not be using. (like employee stock options, real estate) Is there a reason for/against using these options?

As I am reflecting on the current long term investments it is easy to see that I should be doing more. I have only one; a 401(k) plan through my employer. However, I am currently saving $100 each month that will be put towards a No-Load Roth IRA. In my research I found that I need $3000 to open the account, so it is a slow process. In the mean time I am investing in the 401(k) program though my employer.

The 401(k) is the only “retirement” plan through my employer. The owner gives each employee 6% of their annual salary. There is no matching; just the straight 6%. That is great, but it does not give any additional incentive to invest more as the employee. I invest an additional $87.50 each two week pay period. My current account balance is $14,743. According to a 401(k) Savings Calculator (CCH, 2008) at age 65 my balance will be $1,705,014. This calculation was using a very conservative 7% annual return and assumed that my salary would increase at a 3.5% rate each year. This includes my continued $175 monthly investment and the 6% through work.

The other investment I plan to make is the Roth IRA. Although the account is not started I have saved $1100 to date and plan to contribute $100 monthly. If I start this plan as scheduled, the account balance at retirement will be $225,477 using the same conservative 7% annual rate of return using a Roth IRA Calculator (CCH, 2008). As my income increases I plan to put additional money in to this account and start one for my wife as well. However, those plans will be left out of the analysis.

With those two investments totaling $1,930,491 at retirement. There are some variations that could be looked at, the most obvious of which is a higher rate of return. If I use the average rate of return of the S&P 500 of 11.4% (Glassman, 2008), that total would rise to $5,915,517. Getting those historic returns would be great, however according to Dent (June 2008) the next several years may not be so good. I still have 38 years to weather any storms that come my way, but it would be nice to have almost $6 million when compared to $1.9 million. Honestly I don't know what I would do with either of those sums of money. I could easily live off of 5% return each year an not have to reduce the principal.

The benefits of a 401(k) plan are threefold (CNNMoney.com 2008):

A 401(k) represents a way to reduce your taxable income since contributions come out of your pay before taxes are withheld; many plans include a matching contribution from your employer; and the money you save benefits from tax-deferred growth, which lets your money compound more quickly than it would if it were taxed yearly.

This means that all my income dollars are reduced by up to $15,500 (the annual maximum) which reduced the taxes I pay today. Then the taxes that would have been removed (if it were taxed before I payed into the plan) are now earning returns for me. I do not have a benefit from the matching program, but it is still a free 6% each year for me personally. The Roth IRA has one distinct benefit as well: “the earnings on your investment are free from Federal income taxes” (Wachovia, 2008). There are several restrictions that apply, but as long as investors are working within the established guidelines, it is a great secondary investment after the 401(k).

I would like to have approximately $2 million nest egg when I retire. According to Kiplinger.com (2008), somewhere between $500,000 and $1 million is enough to cover most expenses in retirement. They were figuring in a social security check which I am not anticipating, and I want to travel internationally as much as possible.

Looking at the future, I have changed my mindset to some extent. I realize that investing to the maximum in my 401(k) is probably a good idea. I will get some additional input from my (future) financial advisor before making my final choice, but it seems like it may be better to reduce my taxable income as much as possible. I would also like to increase my contributions once I have eliminated my debt.

Resources:

CCH (2008). Financial planning toolkit. Wolters Kluwer. Retrieved August 14, 2008 from: http://www.finance.cch.com/sohoApplets/Retire401k.asp

CNNMoney.com (2008). Money: 101, lesson 23, 401(k). CNN. Retrieved August 15, 2008 from: http://money.cnn.com/magazines/moneymag/money101/lesson23/

Dent, H. S. (June 2008). H.S. Dent forecast: The economic guide for effective financial decision making. Retrieved August, 12, 2008, from www.hsdent.com

Glassman J. (2006). Why I love dividends:Dividends force managers to make the case for reinvestment. That's a very good thing. Kiplinger.com. Retrieved August 15, 2008 from: http://www.kiplinger.com/magazine/archives/2006/08/glassman.html

Kapoor, Dlabay, Hughes (2008). Focus on personal finance: an active approach to help develop successful financial skills, 2nded. McGraw Hill Irwin, New York.

Kiplinger.com (2008). The basics: How much do I need to retire? MSN Money. Retrieved August 15, 2008 from: http://moneycentral.msn.com/content/Retirementandwills/Createaplan/P142702.asp

Wachovia (2008). Tax planning: Roth IRA. Wachovia. Retrieved August 15, 2008 from: http://www.wachovia.com/personal/page/0,,505_3846_4745_4773_4778,00.html