Baby Step 4 - Invest 15% of your income - Unpacked

I read an article this weekend in Money magazine that got me thinking.  So many of the people I meet are focused on Baby Steps 1-3.  These steps are foundational to personal financial stability.  When your focused on these steps Baby Step 4 and beyond seem like a long way away.  So what happens when you get there?  In most cases your unprepared.  Below I will unpack your options and hopefully provide a matrix for you to consider your own situation.  For more info on the Baby Steps click here

So what is all the hub bub that Dave Ramsey and investment professionals are jousting on twitter about?  I'm not going to debate the "Can you get 12% returns" in this post, it has already been done ad nauseam.  The article did get me thinking about the types of investment professionals you can partner with and how they are compensated.  I manage our own investments and help my Mom with her's I have chosen to use more than one of the options below.  My learning through this process is that there is not one answer that fits all situations.  The #1 thing to building wealth is to get out of debt, pay cash, live on less that you make and to intentionally invest consistently over a long period of time.  Or win the lottery, sorry I couldn't resist please don't start playing the lottery now. 

In general the more "actively" your money is managed the higher your cost will be to you.  This range can be from 0.15% on the low end for passively managed ETF's up to 2% for a combination of a active fund management and mutual fund expenses.  Over the course of your investing lifetime this can really add up.  Most of us can meet the Baby Step 4 recommendation of 15% invested for retirement through our employer sponsored retirement plan.  If your employer sponsored plan does not offer a match and your not subject to AGI phase out limitations you should consider a Roth or Traditional IRA contribution into a personal account before participating in the employer sponsored plan.  This is a little extra work but opens up significantly more mutual fund families you can pick from.  Research tells us most of us will switch jobs, employers, and even careers multiple times during our working lifetime.  This can result in multiple investment accounts with multiple investment companies.  I recommend you consolidate these accounts with the investment professional / strategy that you decide to use rather than keeping them in the old employer account or rolling over into the new employer. 

Here are a few investment concepts to familiarize yourself with:

Passive Investment Strategy
Active Investment Strategy
Asset Allocation
Rule of 4% 

Below is a list of the most common investment compensation structures

1) No Load Mutual Funds and ETF's - There are a number of high quality no load mutual fund company's that have low costs and lot of options.  You can select an asset allocation that meets you needs based on risk tolerance and stage of life.  This method is going to be more hands on and require some level of comfort and knowledge on your part.  This is the self serve route.  You can use Money Magazine, Kiplingers Personal Finance for a good list of funds they recommend.  This is what I do personally and try to model my investing on the advice of Jack Bogle.  I also use method 4 below for funds I'm a fiduciary for.  

2) Mutual Funds with a sales load (commission) - You will meet with an investment professional that will make recommendations on how to invest your money.  They are compensated based on the funds you purchase via whats called a "sales load" usually up to 5.25%.  This is the most common way, according to the Money Magazine article above, that Dave Ramsey's ELPS are compensated.  You need to screen for the heart of a teacher not a salesman here.  If you think they would be selling used cars if they weren't selling mutual funds, run!  This person will not have a legal fiduciary responsibility to you.  A fiduciary is required to put the clients interests first and this is a good thing.

3) Fee based financial adviser -  The financial adviser charges for their advice.  Usually an hourly rate.  This separates the advice and compensation components of the relationship.  It would not be unusual for the adviser to act as a fiduciary and be willing to commit to this in writing.  For a list of fee based advisers please visit:  http://www.napfa.org/

4) Percent of assets under management financial adviser - The financial adviser charges a fee for their services based on a percentage of your assets.  The fee can be up to 1.5%.  This fee is received regardless of performance of your investments.  Depending on the types of investments the adviser is selecting your total cost of advise can exceed 2%.  The advisory may or may not be acting as a fiduciary with this structure.  I recommend one that is a fiduciary.  I also use this method.   

If you have assets to invest outside your employer sponsored retirement plan this can be a complicated and emotional decision.  There are very sophisticated companies and investment professionals competing for your patronage.  I encourage you to go slow and make your decision based on research and information, not emotion or fear.  There is no one size fits all answer.  Regardless of which investment option is best for your situation being actively involved in the decision process is critical.  

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