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It's all about the contribution rate
Old 09-17-2012, 06:17 PM   #1
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It's all about the contribution rate

Putnam Investments has just released a new study that looks at the effect of fund selection, portfolio allocation, rebalancing and contribution rates on portfolio size. Turns out that the percentage of income you contribute is by far the largest determinant of your ultimate nest egg.

Over a 29 year period:

1) being prescient enough to only choose top quartile funds versus 4th quartile funds improves ultimate portfolio size by 22%;

2) asset allocation tilted more toward growth increases ultimate size by 17%;

3) regular rebalancing improved portfolio size by 1.5%;

4) increasing percentage of salary contributed from 3% to 4% increased ultimate portfolio size by 33%.


https://content.putnam.com/literature/pdf/PI007.pdf

As some here would say, "In other news, water is wet."
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Old 09-17-2012, 09:13 PM   #2
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Originally Posted by Gumby View Post
Putnam Investments

Over a 29 year period:

1) being prescient enough to only choose top quartile funds versus 4th quartile funds improves ultimate portfolio size by 22%;
I realize the source of the study, and that it could have been suicide to do so, but I'm just curious what would the result have been if they used an index fund at a true expense ratio (i.e. like an S&P 500 index fund w/ total expenses of like 0.40%, not an 'average' 401k expense ratio of 1.10%), rather than the funds they did use in the different scenarios. THAT, I would have paid money to see.
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Old 09-17-2012, 09:43 PM   #3
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Would have looked a little different if 16% of income was invested instead of 15%. Not quite as impressive then.
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Old 09-17-2012, 10:00 PM   #4
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As some here would say, "In other news, water is wet."
They had to write a paper to show that 4 is 33% more than 3 ?
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Old 09-17-2012, 10:19 PM   #5
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They had to write a paper to show that 4 is 33% more than 3 ?
Very true, but if you have had the privilege to hang around some dumb people like I have, you would find some people think that going to 4% is only a 1% increase from 3%. And you get 33% more money, what a deal!
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Old 09-17-2012, 10:19 PM   #6
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Interesting.

What I would be curious is to what's the impact of getting hit by a major recession at the beginning, middle, and end of one's working career. Also, 30 years seems a little long for people who want to ER.
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Old 09-18-2012, 02:56 PM   #7
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Interesting.

What I would be curious is to what's the impact of getting hit by a major recession at the beginning, middle, and end of one's working career. Also, 30 years seems a little long for people who want to ER.
I don't know about that.
Start career after college and or grad school at age 25.
Save for 30 years.
Retire at 55.
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Old 09-18-2012, 03:22 PM   #8
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Would have looked a little different if 16% of income was invested instead of 15%. Not quite as impressive then.
very true... but if a person were able to save twice what they did towards retirement (say 20% instead of 10%) their entire career they likely could have either A) retired a decade earlier... or B) ended up with twice the nest egg. Usually its some combination of the two.

I think the problem is that some people default to whatever their match is (if that) and think that investing above that is a waste because you're not getting as much bang for their buck. Psychologically it is hard for them to get past the following:

[insert name here] contribute 4% plus get 4% match (8% total) and that'll give me $XYZ at age 60... now, lets say I wanted more so I started saving twice as much (8% plus 4% company match to get to 12% total) which equals $XYZ * 1.5 - no way I'm contributing twice as much to only get 50% more later.

I've had this discussion with a few friends and they can't get past this hurdle. My approach has always been to try and show them that if they increase their contribution by 1% a year for 10 years they'll put themselves in a much better position with very little pain.
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Old 09-18-2012, 04:39 PM   #9
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I don't know about that.
Start career after college and or grad school at age 25.
Save for 30 years.
Retire at 55.
You're right. I'm thinking of my own circumstances here -- 10-15 year work period and save as much as possible (20-50%)
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Old 09-18-2012, 04:46 PM   #10
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Originally Posted by photoguy View Post
Interesting.

What I would be curious is to what's the impact of getting hit by a major recession at the beginning, middle, and end of one's working career. Also, 30 years seems a little long for people who want to ER.
I had a very long post on this in the spring (I'll try to find it to link) showing that assuming someone gets hit by recession at some point in their career, it is a HUGE advantage for it to be early rather than late for obvious reasons.

You can demonstrate this very easily with excel. Here is just one example to show the point:
Working time = 35 years
Starting Salary = $50,000
Raise = 4.5% a year
Retirement Savings = 15% a year

Scenario A = returns in the first 3 years are -35%, -20% and -10%, all other years are 10%
Scenario B = returns in the last 3 years are -10%, -20% and -35%, all other years are 10%

The total rate or return for both accounts is exactly the same... about 6.75% a year but the ending results are drastically different. Scenario A ends up with a nest egg of $3,159,144 while Scenario B ends up with $1,230,821

Just because the 3 bad years of returns totaling an overall loss of 53% of the market hit at the end of their saving years vs the start.

Also for comparison purposes. Just getting a flat 6.7% return for all 35 years (the average return of each of each A and B above) will leave you with $1,797,097


The moral... assuming the market corrects and better years are ahead to make up for bad years now, it is actually to your advantage to have a recession during your early years of investing (those in their 20's and 30's are lucky... at least the ones who are saving)
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Old 09-18-2012, 07:31 PM   #11
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EvrClr -- I see what you're saying but I think it may be a little more complicated than your example for the following reasons:

(1) The retiree may have the ability to time when they leave the employment market. So they may be able to hang on another couple years for the equity prices to recover (as they have from the 2009 lows).

(2) The early retiree will be at the peak of their earnings if the market tanks near the end. If they have a high savings rate, all of their additional income can be used to buy equities at very low prices.

(3) The ER person will have a much larger stash of cash (to buy in) and bonds which can do very well in a flight to safety.

(4) The expected returns going forward may be much better if prices (P/E ratios) are depressed compared to if they retired at the end of a bull market. This is the year 2000 retiree scenario.

Obviously there are many pitfalls and not everybody will successfully navigate their finances through a recession. But based on this board, it seems like despite the current great recession many folks have their portfolios at all time highs.
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Old 09-20-2012, 07:38 AM   #12
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EvrClr -- I see what you're saying but I think it may be a little more complicated than your example for the following reasons:

(1) The retiree may have the ability to time when they leave the employment market. So they may be able to hang on another couple years for the equity prices to recover (as they have from the 2009 lows).

(2) The early retiree will be at the peak of their earnings if the market tanks near the end. If they have a high savings rate, all of their additional income can be used to buy equities at very low prices.

(3) The ER person will have a much larger stash of cash (to buy in) and bonds which can do very well in a flight to safety.

(4) The expected returns going forward may be much better if prices (P/E ratios) are depressed compared to if they retired at the end of a bull market. This is the year 2000 retiree scenario.

Obviously there are many pitfalls and not everybody will successfully navigate their finances through a recession. But based on this board, it seems like despite the current great recession many folks have their portfolios at all time highs.
All good points... and exactly why it is good to have a plan and stick with it. If you invest early enough and give yourself enough years in the market you'll have both good and bad times. Key is to not cut back when times are good or bad thinking that the game has changed...
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Old 09-20-2012, 08:43 AM   #13
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I don't know about that.
Start career after college and or grad school at age 25.
Save for 30 years.
Retire at 55.
Working 30 years and retiring at 55 certainly beats working 40 years and retiring at 65 ... but neither scenario seems like ER to me! YMMV
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Old 09-21-2012, 11:01 PM   #14
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Originally Posted by EvrClrx311 View Post
I had a very long post on this in the spring (I'll try to find it to link) showing that assuming someone gets hit by recession at some point in their career, it is a HUGE advantage for it to be early rather than late for obvious reasons.

You can demonstrate this very easily with excel. Here is just one example to show the point:
Working time = 35 years
Starting Salary = $50,000
Raise = 4.5% a year
Retirement Savings = 15% a year

Scenario A = returns in the first 3 years are -35%, -20% and -10%, all other years are 10%
Scenario B = returns in the last 3 years are -10%, -20% and -35%, all other years are 10%


In this example, a retirement would be at 50% of final income or less.
The total rate or return for both accounts is exactly the same... about 6.75% a year but the ending results are drastically different. Scenario A ends up with a nest egg of $3,159,144 while Scenario B ends up with $1,230,821

Just because the 3 bad years of returns totaling an overall loss of 53% of the market hit at the end of their saving years vs the start.

Also for comparison purposes. Just getting a flat 6.7% return for all 35 years (the average return of each of each A and B above) will leave you with $1,797,097


The moral... assuming the market corrects and better years are ahead to make up for bad years now, it is actually to your advantage to have a recession during your early years of investing (those in their 20's and 30's are lucky... at least the ones who are saving)

In this example, a retirement would be at about 55% of final income or less. Income at end of 35 years is 233K a year. Much of the savings would have to be after tax, because 401k Max limits. A retirement income in this scenario is 72K to 126K with a 4% WITHDRAWAL RATE, which is pretty light coming from a 233K income.
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