In the previous chapter, I talked about dividing your income into three separate and distinct streams: a spending stream, a retirement stream, and a discretionary investing stream. Believe me, retirement deserves its own stream, but it doesn’t have to be a third of your income, or anything like a third of your income, because—that’s right—the future is cheap! When we talk about retirement today, we might well mean twenty or thirty years of rest and relaxation. Considering how new drugs and medical technology are extending our life span, you could spend a third of your life or more in retirement. If you choose to take advantage of the permanent fire sale on the future by investing in your retirement today, you’re making it exponentially easier for yourself down the road. You really should not expect to keep working after you hit 70, and even 70 is pushing it for some people. We’re talking about decades of your life when even if you can work, it’s going to become a lot more physically taxing. We all age; that’s just a fact of life. Keep in mind, you’re listening to a guy who had to retire from the hedge fund game at the spry young age of 46 because the stress was almost sure to cause me multiple heart attacks and undeniably caused me absolute misery. In other words, I wanted to walk out, not be carried out in a box.
You might be wondering why I’m wasting your time with the same brand of vanilla conventional wisdom you could pick up in any book off the personal finance shelf at your local library. I’ve got two reasons. First, funding your retirement is so important that I’m happy to repeat myself and everyone else who writes about money, drilling the point home. Investing for retirement so you can live out your golden years in wealth and comfort is just that important. It’s so important that investing for retirement needs to be your first priority after you’ve taken care of everything that could send you hurtling down into poverty. Second, my take on how you should actually go about investing for retirement, using the standard tax-favored retirement accounts, goes beyond the standard, soporific advice you’ll hear from anyone who claims to be a financial expert. Most of these folks assume that their readers (how do I put this delicately?) are functionally brain-dead. They act as if IRA and 401(k) investing is a walk in the park, the kind of easy steps you can take to building long-term wealth that hardly even need to be explained beyond the basics. Or, worse, they skate: they don’t think it matters, in part because they have never run money professionally or even made a lot of money. Which is why, not to brag or anything, I’m different. This is where I part ways with the conventional wisdom crowd. True, you can take advantage of these plans and make a killing without too much effort, but I am constantly amazed at how often people underestimate just how easy it is to mess up and wipe out all of their retirement capital. You have to understand that there are opportunities aplenty for anyone to ruin a perfectly good chance at the easy life, and unless you know how to avoid these pitfalls, you’ll drop right in, taking your retirement capital down with you. I can teach you how to make the best of your 401(k) and IRA investments, how to achieve capital appreciation over the long term with this money, but that’s not my most valuable advice. Remember, when we invest for the long haul, capital preservation tends to be more important than capital appreciation, and when we’re talking retirement, capital preservation becomes even more significant. You’ve got great opportunities to make profits, but there are plenty of legal ways the financial services industry can cheat you out of those gains. It’s particularly painful when I see so many fees these days that are charged for services that I used to provide for free as a broker, or as a favor to my hedge fund clients. But it’s not just the industry that cheats you. I’ve seen plenty of people cheat themselves, especially when it comes to building up funds for retirement. Don’t worry too much, just be cautious. I’ll walk you through every step on your way to a prosperous retirement, and I’ll make sure you don’t get burned by the usual mistakes that so-called experts often forget to warn you about, or even try to talk you into!
In the old days, our parents and grandparents could rely on pensions and Social Security to provide for them in their old age. They didn’t need to worry about retirement. Nowadays, thanks to the magic of capitalism, through 401(k)s, IRAs, and perhaps someday in the not-so-distant future semiprivatized Social Security, most of us are no longer held hostage to the performance of defined benefit pension plans that pay out only so much money and therefore limit how much growth we can see from our retirement savings. Today we have the freedom to manage our own retirement plans. We’ve been given the precious ability to sink or swim based on our own investing prowess, financial knowledge, and self-discipline. Unfortunately, for a lot of people that means they’re sunk. It’s terrific that we have the opportunity to make much more money with a 401(k) plan than anyone ever could have expected from a pension, but few of us have the tools to make that opportunity a reality. I knock 401(k) plans, but in all honesty, having an employer-funded defined benefit pension plan is far, far worse.
I really feel for the guys who work for Tribune Co., the big newspaper company (think Chicago Tribune, L.A. Times, and Newsday, among others) that, as I write this book, is being taken private by Sam Zell. The poor employees at this company have an old-fashioned pension that’s run by the company, which means that if Tribune goes bankrupt, the employees lose their pensions. When companies get taken private, they take on a lot of debt to finance the deal, because all the shareholders must be paid for their shares. The Tribune deal is being financed as an employee stock ownership plan, which basically means that if Tribune can’t repay its debt, then the employees will end up paying for it out of their pensions. If we had a serious Labor Department in this country, no business would be allowed so blatantly to take advantage of its employees. As it is, I’m not even sure most of the employees at Tribune know that they’re getting a raw deal. I’m sure many of them have been sold on the idea that they’re being allowed to participate in and reap the rewards of a fabulous deal, the kind of deal that regular people would never get a piece of in normal circumstances. But in fact, the Tribune employees are being brazenly exploited, and at the same time their bosses are probably telling them how lucky they are to be in this position. I know I have an over-the top, amoral persona on my TV show, and I’ve always maintained that good investors need to be able to put their money in companies that do bad things—although there’s a line that cannot be crossed—but what’s happening now at Tribune is the kind of thing that makes me sick.
How can regular people, who really have never been taught about investing, turn this around and actually provide for themselves, at least when they retire? Where are you going to learn everything they don’t teach in school? There is good advice out there, but there’s no good way to tell the difference between helpful and harmful suggestions unless you’ve already made yourself rich and no longer need someone else’s input about money. For most of you, that means you’ve had nowhere to go to learn how to set yourself up for retirement the right way without also having to hear a lot of useless or, worse, damaging nonsense. I am writing this book to take care of that problem.
I have always felt that I should leave any kind of discussion about saving for retirement to those who toil in the personal finance industry. I figured they were the experts on the subject, and since I specialized in making enormous sums of money in the stock market, my knowledge wouldn’t really apply to the personal finance universe. I erroneously believed that the world of building enough wealth for a comfortable retirement didn’t really intersect with the world of running a hedge fund. Then I read the many personal finance books and columns about retirement and I realized that most of the writers who cover this ground knew only what the terms of these retirement plans were and left you to figure out how best to use them. That’s nonsense! How to properly use your retirement plan is the most important topic of them all, way too important to leave to the people who administer the plans or the people who write about them all the time, even though these writers have no particular insight into investing. You’ve heard a
lot of this before, but you’ve never heard it from someone who’s actually made a lot of money investing, and I think that makes all the difference. I just can’t imagine how people can dole out advice about managing a retirement fund properly unless they themselves have already made a fortune or two using the same fundamental disciplines. The fact is that nobody writing books that tell you how to save for retirement actually has any experience successfully turning money into more money. Few people who are already rich have any incentive to write a book full of personal finance guidance. I don’t have a serious financial interest in writing this book, because after a point, making more money starts to become pretty meaningless. I have never understood why I’m so driven to help people, or as my critics would put it, to shoot my mouth off, but at least my advice comes from the perspective of someone who has gotten rich and stayed rich.
If you feel as if we’re going backward by starting with your need for lasting wealth in your retirement, then you understand exactly what’s going on here. Channeling money into the retirement stream of your investments is priority number one. Investing in your 401(k) and an IRA is more about staying rich than it is about getting rich. You don’t hear of too many 401(k) millionaires, but I have seen plenty of them. Mostly they’re the ones who started with 401(k)s when the government first allowed them. I don’t blame you for thinking that the money you contribute to your 401(k) won’t add up to something big. I can remember when I was working at Goldman Sachs and I wanted to lay the groundwork for my clients by setting up their 401(k)s, which at that point were still a novelty. I was told not to bother because the money wouldn’t amount to anything. My boss at Goldman Sachs, who was a savvy guy, said that. Everyone else makes the same mistake. Of course, 401(k) money is now the single biggest pile of retirement funds out there, and it just gets bigger and bigger. I need you in on the action. You don’t have to get rich first in order to start laying the groundwork for staying rich. Just the opposite is true, actually. If you don’t take full advantage of these plans from the get go, it’s going to be much harder both to build your wealth and to keep it if you manage to amass a large nest egg. You want to take advantage of these tax-favored gifts from the government. As soon as you have a plan to hang on to your wealth long after you retire, a plan that should involve a 401(k) and an IRA, only then can you start taking chances with the discretionary side of your investments. I know this is a really tough thing for many people to do, and I’m sure a lot of you are now quite upset with me for making this judgment, but it’s the right one. When I do my college tours for Mad Money, I never hear of people investing their money in an IRA. All the college kids are taking fliers, Wall Street gibberish for chasing hot stocks. Now, I know most of them don’t have serious sources of income that they can devote to anything other than paying off student loans, but they should take whatever money they have to invest and put as much of it as they can stand toward retirement. You take fliers after you’ve nailed down your first retirement contributions. I’m telling you: retirement is the highest financial priority there is.
Some things you don’t want to take big chances on, and your ability to retire with plenty of money to spare is definitely one of them. Take care of your long-term prospects, and only then should you start fretting about the short term or the medium term. Even though you need to pay this month’s bills well before you retire, if you are smart you will prepare for the long run first. Why is that? Why should we turn the world upside down and come at everything backward? Why does the horde of personal finance authors tend to take the same approach?
It’s not because you are building wealth for decades down the road, putting together enough retirement capital along with something to pass along to your children. It’s not because it’s the responsible thing to do. It’s not because you don’t want to come up short on cash when you start having a harder time supporting yourself. It’s not even because living from Social Security check to Social Security check is a pretty tough and undesirable bit of financial trouble. I should add that depending on when you were born, there’s no guarantee Social Security will even be there when you retire. I can say without a doubt that you’ll either be collecting those Social Security checks later than you expected or they’ll be smaller than you expected, because the economics of the program will force either an increase in the retirement age or a decrease in the size of payments. Every one of these things is true, but they’re not why we’re always told to put retirement first.
What’s the real reason? Because it’s easy to set up plenty of retirement capital, and the sooner you get started, the cheaper the future becomes. The simple truth is that thanks to the power of compound interest and the generosity of the federal government, setting yourself up for a flush retirement is one of the least difficult elements of long-term financial planning. Don’t get me wrong: depending on your circumstances, building enough wealth for a comfortable and secure retirement can be anything but a cakewalk. And I don’t want to belittle the daily struggle many retirees face just to make ends meet. Far from it; my goal is to help create long-term prosperity for people of all ages. But investing to support yourself in the future is one of the least difficult things to do here and now.
You know the steps already. If your employer offers a 401(k) retirement plan, then the best use of your capital, from a long-term perspective, is almost always to contribute to it. Almost always. I’ll take you through all the ins and outs of 401(k) investing in a moment, but first we need to go through the rest of my plan. Ready? You should also start up an IRA, and actively invest in that as well. If you’ve only got the income to afford funding one or the other but not both, you should go with your 401(k) contributions first (except in a very few situations, which I’ll describe). You should be saving as much as possible so that you can invest as much as possible, but you might not have the money to fund both accounts and still manage to make ends meet. If you’re in that situation, you can still use your capital to ensure a cozy retirement, even without much income. After all, that’s the whole point here. The entire premise of this book is that your salary won’t be enough to create true, lasting wealth. That’s why you ought to take as much of that salary as possible and turn it into the kind of money that makes more money: capital. That’s the plan, minus all the caveats I’m about to share with you: contribute to your 401(k) plan if your employer provides one, and then contribute to your IRA after that. Sounds simple, but there’s a right way to go about this kind of investing and countless wrong ways. Remember that the future is cheap as long as you pay for it in the present, and that’s exactly what it means to invest using these two tax-favored plans.
I wish I could unequivocally tell you to fund your 401(k) plan at least so that you get the full matching contribution from your employer, fully fund your IRA, and leave it at that. I wish it were that easy, as easy as it’s ordinarily made out to be by the industry of authors who extol the virtues of tax-favored retirement plans while at the same time rarely explaining in any useful way how you should actually take advantage of them. But fortunately for you, I’m a worrier, and I would be worried sick about the safety and security of your retirement dough if I didn’t tell you about the downside. Let’s start by looking at your 401(k) if you have one. This is going to be the first and best place for many of you to start investing.
If you’re going to take my advice, you need to know that I’m being completely honest with you. So when it comes to 401(k) investing, I have to tell you that there are only two good things to say about a 401(k) plan, just two positives, but they’re so good that they more than make up for all the faults of the average 401(k)—and there are a lot of faults. The first positive is that your contributions to a 401(k) plan are made with pretax income; the taxes on each contribution are deferred, along with the taxes on any earnings from your 401(k) investments, until you start withdrawing money from the account after you’ve retired, and then you’ll pay ordinary income tax on any withdrawals. This tax benefit alone is enough t
o make even the worst 401(k) plan worth your time and money. I don’t like to complain about taxes; in my own personal history, the way I’ve invested has meant incurring a lot of tax charges. I can live with that, but why put up with taxes when you don’t have to? You can compound your money year after year without paying a dime of tax on your gains. But outside of a 401(k), your investment gains would be taxed when you realized them, when you sold something at a profit. Inside your 401(k) the government doesn’t take its cut of your capital gains. That leaves you with more money to continue to invest in your 401(k) plan, and over time the tax advantages really add up. In fact, the tax advantages are evident and pretty helpful from the get-go.
Suppose you make $50,000 a year. Your marginal tax rate is going to be 25 percent with that level of income. Now let’s say you follow my 10 percent rule of thumb, and invest $5,000 a year in your 401(k). All of a sudden, you’re not paying any income tax on that $5,000. You would have had to pay the government $1,250 in income tax on that $5,000, but you get to defer that tax bill until after you’ve spent years or even decades putting that extra $1,250 to work. In thirty years that $1,250 will look more like $9,515.32, assuming you compound at a 7 percent annual rate, which is conservative for a stock portfolio but, given the high fees associated with 401(k) plans, seems like a reasonable assumption. If we look only at the earnings you would generate entirely from the tax savings of a single year, we’re talking about an $8,265.32 profit. When you start taking money from your 401(k), you’ll have to pay income tax on those withdrawals, but considering the tremendous profit you made merely by deferring the income tax on a single $5,000 contribution to your 401(k), I doubt you’ll be too bothered by the tax. Still, you’ll have to keep track of inflation, of the overall increase in prices while you’re earning those extra returns with tax-deferred dollars in a 401(k). If we assume that we have a 3 percent increase in prices every year, which is a little on the high end, then over thirty years, the general price level will have increased by 143 percent. What costs $1.00 today will cost $2.43 in thirty years if prices rise at 3 percent annually. That means that in thirty years your $8,265.32 will pay for what $3,401.43 would cover today. That’s still a tidy gain compared to the big fat $0 you would have produced had you not invested in your 401(k).
Jim Cramer's Stay Mad for Life Page 7
