Saver’s Digest 2nd Quarter, 2011
This latest issue of Saver’s Digest: information on how to maximize your workplace retirement savings plan. Take a look at a PDF version here!
Casting a Wider Net: Adding International Stock Funds to Your Retirement Savings Mix
If you are like many Americans, you probably don’t give a second thought to driving a Japanese-made car, talking on a Korean- made cell phone, or enjoying French wine and cheese. So why is it that, when it comes to their retirement savings, some people shy away from international investments?
Perhaps it’s a belief that international stocks are simply too volatile or too risky. While these are legitimate concerns, ignoring the long-term potential of international stocks could cause you to miss many of the world’s best growth opportunities.
In today’s increasingly globalized economy, many of the fastest growing economies and best-run companies can be found outside the U.S. In fact, only two of the world’s 10 largest corporations and six of the top 20 maintain headquarters in the United States. (Source: The Fortune 500)
Developed Economies vs. Emerging Markets
To take advantage of growth opportunities around the world, you may want to consider allocating a portion of your retirement savings to funds that invest in international stocks. Before jumping in, however, under- stand the differences between funds that invest in “developed” economies, such as those in most of Europe and Japan, and funds that invest in “emerging” markets such as Brazil, Russia, India, and China (the “BRIC” nations).
Financial markets in developed countries tend to be more liquid and better regulated than those of developing countries, and their stock markets are generally less volatile. While emerging markets often have higher econom- ic growth rates than those in the developed world, they can also be extremely volatile.
For example, in 1997, the so-called “Asian Contagion” crisis led to widespread problems among Asian banks and severe stock market losses. In 1998, Russia default- ed on its government bonds. More recently, events in Egypt and elsewhere in the Middle East have demon- strated how political unrest can create challenges for international investors.
Over the past decade, however, many emerging nations have implemented structural reforms that have encouraged their financial institutions and government entities to clean up their balance sheets by reducing debt. Unlike some Western nations, many of these coun- tries don’t face huge government budget deficits, high levels of consumer debt, or weak real estate markets. In places like China, Brazil, and Indonesia, a rising middle class is creating new demand for products and services.
On the other hand, the governments of emerging economies may be less experienced in their manage- ment of economic boom and bust cycles, and their markets are subject to greater political and currency- related risks. In several instances foreign governments have taken over (or “nationalized”) companies without adequately compensating shareholders.
Start With a Core Fund
Just as you would create a domestic stock fund portfolio by first gaining broad exposure to the U.S. market, consider investing in a diversified international fund that targets developed non-U.S. economies around the globe. A “core” international mutual fund can provide exposure to overseas markets by investing across a variety of developed regions, countries, and industries.
Another option is to invest in a core “global fund.” Unlike international funds that focus on non-U.S. companies, global funds invest in both U.S. and non- U.S. companies. Before adding foreign investments to your portfolio, however, you may want to check to see whether some of the funds you already own hold international stocks or U.S. multinational companies that have extensive business operations overseas.
Add Some Spice to the Mix
Consider allocating a smaller portion of your retirement savings to complementary international funds that target certain regions, such as emerging markets. The idea is to add funds that are not highly correlated to your core international fund. Asset classes with low correlation are influenced by different factors and move in the same direction less frequently.
Know the Risks
Recent volatility in international markets, especially emerging markets, underscores the fact that you need to have a long-term investment horizon when investing overseas. Understand that you may have to tolerate periods of extreme market volatility. For example, the MSCI Emerging Markets Index fell 53% in 2008 and then rebounded 78% in 2009. As with domestic stocks, gauge your risk tolerance before you invest and diversify across a wide variety of investments.
While international stocks can be volatile, the same holds true for U.S. stocks. History has shown that over long periods, there have been stretches of time where international stocks have outperformed U.S. stocks, and vice versa. By owning a mix of both, you may be able to enjoy lower volatility and profit from the trend toward a more globalized economy.
Factoring Medical Expenses into Your Retirement Plans
What’s your vision of the ideal retirement? Some people dream of leaving the rat race behind and exploring the world. Others simply want to pay off the mortgage, get the kids through college, and relax with family and friends. The common, often unmentioned assumption in most retirement planning scenarios is access to high quality health care.
The hard fact is that health care coverage comes at a high cost that is likely to go higher in the years to come. According to a recent study, a 65-year old couple retiring this year will need $230,000 to pay for medical expenses throughout retirement (Fidelity Investments Retiree Health Care cost estimate, March 2011). That figure does not include the potential cost of nursing home care. The good news, if any, is that due to recent health care reforms, the estimated cost actually fell 8% from 2010. However, since this annual study was first conducted in 2002, retiree health care costs have increased by an average of 6% each year.
Another study shows that 92% of American workers either have no idea what their health care costs will be in retirement, or vastly underestimate the probable costs (Sun Life Financial, May 2011). Half of the people in their 50s who were surveyed reported feeling “not at all confident” about meeting their retirement health care expenses and 75% lacked any specific plan to cover medical costs in retirement.
These numbers are even more alarming when you consider that employer-sponsored retiree health insurance, which was relatively common just 20 years ago, is declining quickly. The culprit? A report by the Boston College Center for Retirement Research blames rising health care costs, longer life expectancies, and changes in accounting rules (The Implications of Declining Retiree Health Insurance, August 2009).
This trend is particularly challenging for those who are looking to retire early. Because Medicare coverage does not kick in until at least age 65, many would-be early retirees may need to stay in the workforce longer. No matter when you plan to retire, you cannot ignore the cost of health care, so consider these suggestions to help you prepare for a happy — and healthy — retirement.
Retire Later
Working even just two or three years longer than you planned can help you stash away more dollars in your retirement savings accounts. It also allows you to enjoy more years of employer-provided health insurance (assuming your employer offers health insurance). If you can no longer manage a full- time job, consider working for an employer that provides health insurance to part-time employees.
Save More
If your plan allows you to contribute on a pre-tax basis, or allows you to make Designated Roth Contributions, you can solve many retirement expense challenges by contributing more to your employer-sponsored retirement savings plan.
In 2011, you may be able to contribute as much as $16,500. If you’re age 50 or older, you may be able to stash away another $5,500 each year.
Bone Up On Medicare
As your eligibility date for Medicare approaches, take the time to learn as much as you can about the various Medicare policies available. This includes Part A (hospital coverage), Part B (medical insurance), Part C (Medicare Advantage Plans), and Part D (prescription drug plans). It’s a complex system to navigate and the more you know the better choices you can make. Visit www.medicare.gov for more information.
Take Good Care
It may sound obvious, but spending more time at the gym or exercising at home and less time on the couch can help prevent chronic — and expensive — health problems, such as heart disease or diabetes. Be sure to get regular checkups too, as early detection can improve recovery rates. Many employers offer wellness programs and some offer insurance discounts for workers who quit smoking or enroll in weight loss programs. Check to see if your employer is among them.
Learn The Lingo
Rebalancing
Rebalancing is the process of periodically restoring your portfolio to its target mix of investments. For example, you may have decided to allocate 60% of your retirement savings to stocks, 30% to bonds, and 10% to cash. Over time, however, your asset al- location can change dramatically as certain investments outperform others. Eventually, you could end up with 80% of your assets in stocks, which increases your portfolio’s exposure to a severe stock market decline.
As recent events have demonstrated, the stock market can be extremely volatile. Today’s high-flying stocks can quickly become tomorrow’s laggards. That’s exactly what happened during the boom-and-bust cycle for technology stocks that occurred from approximately 1998 to 2000 and to the stocks of many financial services companies in late 2008 and early 2009.
By periodically rebalancing your portfolio, you can prevent investments that have performed well from taking on too much weight within your overall portfolio.
Trimming back on your winners allows you to protect your gains and position your portfolio to benefit from a change in the market’s direction. Think of it as a disciplined way to potentially sell high and buy low.
Generally, there are two ways to go about rebalancing. You can sell a portion of your portfolio that has experienced strong gains (in effect, selling high) and reinvest the proceeds in assets that are currently underweighted in your portfolio (potentially buying low). Or, you can hold on to your best-performing investments and redirect new contributions to your retirement savings account into underweighted assets. Keep
in mind that with this method, it may take longer to get you back to your target asset allocation.
Another way to automatically rebalance your portfolio is to invest in a “target date” fund designed for the year you plan to retire. A balanced fund that maintains an asset allocation that is consistent with your risk tolerance and investment goals is another option.
The information in this publication is not tax or financial advice. Please review the provisions of your plan and consult with a financial or tax advisor on these and other tax and financial planning matters.