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The Cookiepus Conspiracy

Mindless ramblings, leading to perfect clarity.
Tuesday, January 20, 2004

So anyway here's the deal with Retirement Plans. Right up front, my philosophy
is that the best thing you can do is max out your 401k - ie the limit next year
is 13K so you should strive to put in as close to 13K as possible. You're ahead
with that for a few reasons:

1. You are tax-deffered. Meaning that if you get 1k in your paycheck and invest
it yourself, you're only investing about $700 because that's what you get after
tax. If you invest pre-tax, you're investing the whole 1k, so if it works out
and you get an average of 15% anual return for 40 years on 1k vs. $700, the
difference comes out to several thousands.

2. You work for a financial institution, which means that the people picking
plans know something about what they're doing. Since you have a choice of 8
plans, it suggests to me that they offer plans for various investment horizons
(I have 40 years till retirement while betty only has 5) and risk tolerance (I
will jump out of the window if my fund loses 80% this year, while bob will
handle that fine. this is closely related to your investment horison. If you're
retiring next year and you just lost 80% of your savings, you should jump out!)
This suggests that out of the different categories of funds, the ones available
to you are as good as any you'd pick yourself, especially if you don't know what you're doing.

3. Investing as part of a 401k saves you from paying loads. Loads are basically
fees that funds charge investors to recoup advertising and marketing costs.
These are usually waived when you invest through a 401k. Of course there are
also funds that don't charge loads either way.

4. 401k lets you take out loans against them. So for example in a couple of
years you want to buy a house or appartment. You can take a loan against your
401k. You repay it back, with interest. But the interest goes into your 401k!
You basically act as your own loan bank. The fact that you save on the interest
will save you thousands. Similarly, there are provisions for taking out for 401k for emergencies. The downside, you cannot generally take out of your 401k
except for the above 2 reasons before age of 60. (or 65?)

Ok so now we know that you SHOULD invest. Now we need to figure out how to

You have a choice of funds, and I think it's fair to assume that they range from very safe to very risky. Low Risk = Low Reward. High Risk = High Reward. Being
young and having 40 years until retirement, you have room to play. So your
portfolio should be skewed towards higher risk. (however, if you're a broke old
man, do not hold a grudge against me) PAST PERFORMANCE IS NO INDICATOR OF FUTURE RESULTS!

With the choice of funds that you have, you still need to pick out the good ones from the bad ones. The WORST thing about a fund is how expensive it is. All
funds have an Expense Ratio, which is a percentage of your investment that they
anually take to cover the expense of managing the fund. This is usually related
to how big a name is running the fund. If you want a fund run by a famous
manager with a great history of returns, he's probably going to charge a big
expense ratio.

Why is the expense ratio important? Because if 2 funds make 5% anual gains, but
one charges 2% expense ratio while the other one only charges 1%, your total
return is 3% with the first one (5-2) but 4% with the second one (5-1). Since
the objective is to make as much money as possible, we can go a long way towards that by avoiding PAYING too much. The fact that a fund charges higher expense
ratios does not mean it is necessarily better. If you have 2 funds from the same general class and one is cheaper and has relatively similar returns over the
last 5-10 years, it's a no brainer. Go with the cheaper.

How do you look up expense ratios and classes for your funds? Go to and put in the ticker. There's even a function on there to
"grade" the fund (in stars, I think.) It even gives you a verbal description
kinda like "this fund gets 5 stars because it has delivered higher returns than
class average while charging average fees" or "this fund gets 5 stars because
even though it has average returns for the class, it has charged super-low fees" either way is good. You either spend more and make more, or you spend less and
make less, it works out. There are plenty of funds that are like "this fund has
1 and a half star because it has lower than average returns, higher than average expense ratio, and has a high turnover rate"

What's turn over rate? It means how often a fund buys and sells securities. For
example, if the fund has a mentality of "I know this stock is undervalues so it
has to go up in 2 or 3 years, so I am gonna buy it now and hold it" (btw this
is the right mentality) it has low turn over rate. If a fund has the mentality
of "I am gonna buy this stock cuz it's gonna go up tomorrow... now its tomorrow
and it didn't go up, I am gonna sell it and chase some other one" this is high
turnover. High turn over is bad because you, as fund investor, are paying for
it. Buying and selling incurs broker fees which eat away at your income.

So you basically want, from each class, to seek out funds with low turnover
relative to the class average and low fees relative to class average.

Now, what classes do you want?

Being that you have 40 years to go, you should have about 20% of your stuff
allocated to safe investments (eg: funds that mainly invest in US bonds, money
markets, etc.) and 80% of your stuff in stocks. Stock funds differ, too. Some
are low risk, some are high risk.

Usually, for beginners I recommend to have some share of your stuff in an index
fund. An index fund is just that, it mirrors a published index. For example, the S&P 500. That means that the fund invests in exactly the same stocks and in the same proportion as the S&P 500. That means 2 benefits for you. 1. Since this is a no-brainer operation, there's no expensive porfolio manager to pay. 2. Since
the index makeup does not change radically, these funds have low turnover. For
example, Vanguard S&P 500 (which I'd guess is one of your options) charges 0.20% expense ratio. Other (non-index funds run by big-name managers) charge as much
as 2.0%... The problem with an Index fund is that you can't out-perform the
market. (on the up side, you can't underperform the market, either.) You
basically follow the market. S&P has a good year, so do you. S&P has a bad year, so do you.

Now, how do you spot low-risk funds? Aside from reading on,
check out their returns during BAD market years (like 2001 and 2002) If they
actually MADE money or lost LESS money than the corresponding index, this is a
fairly conservative fund. On other years, you'll see that they usually don't
out-perform the market too much.

Higher risk funds, you'll see that on bad years, they lose MORE than their
index. But in good years they make a LOT more than the index. As someone with 40 years to go, you should have a good chunk of your money invested in funds like
this. Of course you have to gauage your own ability to look at your 401k
statement one quarter and see that a good chunk of your stuff is worthless at

One last thing, and that's diversification. The worst thing you can do is invest in one fund. Because if that fund goes down, that's it. All your eggs in one
basket. There's absolutely no benefit to having a large chunk of your money in
one fund vs having a little bit of money in all funds. In fact, I think that you should invest in all of them (except ones with really high expense ratios,
maybe.) If you really want to take a lazy road, just put in an equal amount of
your 401k contribution into each fund (if there are 8 choices, each one gets
12.5%) and be done with it. I would recomend tweaking it a little bit, though.
For example, you can say "I am really too young to have 12.5 of my money sitting in a money market fund" so you take, say half of your money market fund's
allocation (6.25%) and you put it in some high risk fund - or maybe you'd be
more comfortable with spreading that 6.25 among some of the higher-risk funds,
so that for example 2.25% go to a super-high rish, 2.0% go to the next 2, which
are a bit lower risk. This way you're:

1. diversified
2. skewed a little towards higher risk/higher reward.

you can then fine tune it further. Let's say fund A and B are abount the same
risk/reward ratio. But A is more expensive. So you take 1/2 of your allocation
to A and put it into B instead. That way you are still diversified, but you're a little more skewed towards the fund that is cheaper and should therefore give
you better returns.

So, to summarize:

1. Put in as much into your 401k as you can afford. ***
2. Diversify. ***
3. At your age, lean toward higher risk/higher return funds.
4. Seek out low expense ratio and low turn-over rate (i think it may be called
Beta in the prospectus)
5. Don't freak out when your funds drop. Think of it as an opportunity to buy
shares of it for cheap. Short term fluctuations don't matter when you're
thinking 40 years ahead.

*** 1. if you make 50k, you're paying taxes off of 50k. If you put in 13k into
your 401k, you're only paying taxes as if you were making 37k. That means your
take home pay doesn't decrease by 13k in a year if you put in 13k into a 401k.

*** 2. Some of your funds probably invest in foreign bonds and stocks. That's
also diversification, and you should take advantage of it.

I did some research to show you that how the market is doing right now does not
make a difference to long term investments..

August 1987, you buy $10,000 of some DOW index fund. Dow is at 2721. In Oct
1987, the Dow drops to 1742 (the crash of 1987) and your investments are worth
$6410. You lost nearly 40% of your investment IN ONE MONTH!

Another example:

In December 1999 you buy $10,000 shares of a Dow index fund. Dow is at 11719
(height of the boom). Right after 9/11, Dow drops to 8250. Your investment is
now worth 7142. You lost nearly 30% of your investment in less than a year.

What's the moral?

Right now DOW is at 10581. Which means means your 10K from 1999 assuming you
didn't bail out) is worth $9090. Which means you're only $1000 down. (10%)

But guess what.... If you had stuck around with your 1987 investment, that 10k
from which you lost 40% of in Oct 1987, is now worth $38,910! I.E. it's a good
thing you didn't jump out the window in 1987 or sell all your shit, because it's now worth nearly 4 times as much!

And if you really had balls and on the day it droped in 87 you put in another
10k, THAT 10k would have been worth $60,975 today.

Similarly, if you put in 10k on the day the market opened after 9/11, it would
be worth $12,836 now. You would have gained 20% over 3 years IN A RECESSION!

One more stat. If you bought in Aug 87 (highest point at that time) and had to
retire right after 9/11 (lowest point of our time), your $10k would have still
been worth $30,395!

IE: when time is on your side, local minimum and maximim are irrelevant. In
fact, when the market drops, it's an opportunity for you to buy low and increase your return even higher (as you can tell by the returns you'd get if you had
invested right after 87 or 01 crash)

The averages seem to be in your favor, historically. If you put in a little bit
each month, you get on "average" the fair price for your time period. Similarly, if you had to retire in 2001 after 9/11, your overall portfolio would be worth
less than it is now, but you'd not be taking all of it out. You'd take some out, while the rest of it would grow to present value ;-)


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