Guaranteed 7% return too good to be true??

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hellobogle
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Guaranteed 7% return too good to be true??

Post by hellobogle » Sat Mar 01, 2014 6:02 pm

Hello! I am new to investing, and I would like to take time now to develop a strategy that I can stick to so I can avoid making poor decisions in the future. I think I'm set on a Target Retirement Fund in my Roth IRA. But for my 403b, I'm tempted to go 100% into the Fixed Return fund with a guaranteed 7% return. Or is there a catch?

Emergency funds: 3 month emergency fund
Debt: No debt
Tax Filing Status: Single
Tax Rate: 25% Federal, 6.45% State
State of Residence: New York
Age: 26
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks

Current retirement assets

Pension
2% of max salary ($100,000) each year after 25 years of service
+1.5% each additional year over 30 years
(If I retire when I'm 55, I will have 32 years or 63% of final salary which would be $63,000)
(If I retire when I'm 63, I will have 40 years or 75% of final salary which would be $75,000)

Roth IRA-
$1000 Vanguard Target Retirement 2050 Fund (VFIFX)

403b-Tax deferred
$0

Contributions

New annual Contributions
5% salary to pension
$5,500 to Roth IRA for 2013 and 2014
5-10% salary to 403b

Available funds

Funds available in 403(b)

Fixed Return Fund/Pension Fund: To provide a fixed rate of return, determined by the New York State Legislature in accordance with applicable laws. 7% for TDA investments by members who are serving in (or resigned/retired from) titles represented by the United Federation of Teachers. The crediting rate of 7% has been in effect since December 11, 2009. The prior crediting rate of 8.25% was in effect from July 1, 1988 through December 10, 2009. The Pension Fund consists of U.S. and international equities and fixed-income instruments, with smaller allocations made to private equity and real estate investments. It contains the City’s contributions toward TRS members’ retirement allowances (pension reserves) and members’ contributions to the Qualified Pension Plan (QPP). It also includes the assets of the Fixed Return Fund, an investment option for members that provides a fixed rate of return, determined by the New York State Legislature in accordance with applicable laws.

Diversified Equity Fund: The Diversified Equity Fund invests primarily in U.S. equities. The fund may also invest in international equities and other investments that may exhibit fixed-income characteristics. The objective is to achieve a rate of return comparable to the return of the broad equity market, with less volatility

Bond Fund: The Bond Fund invests primarily in a portfolio or portfolios of high-quality bonds that provide for participant transactions at market value. These bonds may include Treasuries, Agencies, Corporates, Mortgages, and other types of fixed-income instruments. The objective is primarily to seek current income from a diversified portfolio of high-quality bonds.

International Equity Fund: The International Equity Fund invests primarily in the stocks of non-U.S., developed-market companies traded on a variety of stock exchanges and denominated in a variety of currencies around the world. The objectives are to provide long-term capital growth and to achieve a rate of return comparable to the return of the non-U.S. developed equity markets over a full market cycle.

Inflation Protection Fund: The Inflation Protection Fund invests in assets that may include but are not limited to commodities, real estate securities, and inflation-linked bonds. The objective is to provide a positive real rate of return that exceeds inflation over a full market cycle. (PIMCO All Asset Fund PASAX)

Socially Responsive Equity Fund: The Socially Responsive Equity Fund primarily invests in U.S. equities. The fund attempts to avoid companies that receive a significant portion of their revenue from alcohol, tobacco, nuclear power, or weapons. The objectives are to achieve positive long-term capital growth and to earn a rate of return comparable to the return of the broader equity market while reflecting social priorities over a full market cycle. (Neuberger Berman Socially Responsive Fund NBSRX)

Here is a link for more information on the fund options.

Questions:

1. What should be my allocation in the 403b?
I don't really like the fund options because they are actively managed, and the documentation lists 3 pages of manager and management companies. However, after reading posts from other Bogleheads, it sounded like the fixed return fund is almost too good to be true. Apparently the NY state law guarantees it will never drop below 7%. Should I just put everything into the Fixed fund? The only thing is that I am already contributing 5% of my paycheck to this fund through my pension contributions. Is it bad to also invest my 403b into the same fund? I am envisioning the 403b and Roth IRA as a sort of back up incase there are no pensions by the time I retire. But maybe the Roth is enough of a backup? As an alternative, I could do something like the following to be more diversified:
50% diversified equity
25% international equity
10% bond
15% fixed return

2. They say your investment rate matters more than your rate of return when you are just starting out. Can I invest more of my emergency fund into the Roth IRA since I can withdraw contributions without penalty?

3. I am not quite sure when I will retire. It is somewhere between 2042-2049. I chose the 2050 target date fund, but now I am second-guessing myself. The fund is essentially the same as the 2045 but the glide paths are different. I like the idea of the glide path, but I'm not sure of the exact timing I want to make the switch. Does it matter? Is there any downside to changing my investment fund date as I get closer to retirement? Would Lifestrategy fund be better?

4. Should I lump sum, dollar cost average, or value average my contributions to the Roth IRA. Remember, I need to add $4,500 by April 15th.
Last edited by hellobogle on Sat Mar 01, 2014 7:57 pm, edited 1 time in total.

deikel
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Re: Guaranteed 7% return too good to be true??

Post by deikel » Sat Mar 01, 2014 7:48 pm

SInce you are just starting out and have many years to optimize your plan as you go, here are just some thoughts:

- dont count on you pension just yet, you just started, who knows if you will still be at this company/employer in 30 yrs - somewhat unlikely IMO
- AA: Skip the target funds or any % in bonds at this time. Bonds are currently dismal in return and you have so many years to come....no reason to have bonds (aka cash) sitting around idle and not working for you. Yes the market could crash tomorrow, but really if you dont think the market will recover within 30yrs, you should not invest in stocks at all - bonds come into play later in life when you dont want to loose your money when the retirement goal is in sight.
- if you are in the 25% tax bracket, than I assume you would qualify for T-IRA deductions, you should take that tax break rather than paying post tax into Roth ?
- You can borrow against yourself from Roth, but you have to pay it back in the same year I believe - so don't dump your emergency funds in there, they are intended to be cash or its equivalent
- dont do thinks just for tax reasons, consider if you would do it regardless of tax consequences and consider the tax advantage the icing on the cake, not the reason to do it to begin with
- I am not sure I totally understand how your pension works, but basically, dump everything into domestic stock fund with lowest fee structure - the rest is not truely diversified anyway (no need to split US vs ROW) and for stock/bond, see above
- start out simple with a one fund approach (or two since you have more than one account) and try to save as much as you reasonably can, but also work up your emergency funds to 6-12 months of expenses

my 2 cents
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immidiatly and destroy any copy or remembrance of it.

deikel
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Re: Guaranteed 7% return too good to be true??

Post by deikel » Sat Mar 01, 2014 7:53 pm

Oh, I missed the best:

7% garuanteed...indeed sounds to good to be true, is there really something like that ? Last years S+P increase was 33 % or so, so if you had it in S+P500 you made the equivalent of ca 4.5 yrs of this offering...I have no clue if this offering is legit or not, but it sounds rather strange that anyone would garuantee such a return given the current bond market, is this post fees ? What are the fees if not ? I would read much more about this before committing any money into it.

If it is indeed 7% return, I would consider it as a(freaking awesome) bond - no more no less
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immidiatly and destroy any copy or remembrance of it.

MathWizard
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Re: Guaranteed 7% return too good to be true??

Post by MathWizard » Sat Mar 01, 2014 8:15 pm

.
To provide a fixed rate of return, determined by the New York State Legislature in accordance with applicable laws. 7% for TDA investments by members who are serving in (or resigned/retired from) titles represented by the United Federation of Teachers. The crediting rate of 7% has been in effect since December 11, 2009. The prior crediting rate of 8.25% was in effect from July 1, 1988 through December 10, 2009
I would not take the 7% guaranteed, or maybe just put a small portion in it.

The "guaranteed" 8.25% was only guaranteed for 18 1/2 years , how long is the 7% "guaranteed" for?

The 7% return is what the guaranteeing company thinks it can get on the money plus their profit.

I would actually like to get in on a deal like this, on the other side. Especially if I coould lower
my guarantee if economic conditions warranted.

If I could get the contributions of all teachers in New York state always getting new teachers in, I would
guarantee them a 7% return, and keep the excess.
One would probably need a business with lots of assets to meet the regulatory requirements.
Long-term I have no question that I can get 7% nominal. I got about nearly that during the
"lost decade" of the 2000's. If one is maintaining a float of billions of dollars of contributions each year,
and earn just 7.1%, while paying out 7% , the profit is 0.1% of one billion dollars, or $10Million a year.

mnvalue
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Re: Guaranteed 7% return too good to be true??

Post by mnvalue » Sat Mar 01, 2014 8:20 pm

- In the 25% tax bracket, Traditional tax-deferred savings options (in your case, 403b, governmental 457 if offered) should be preferred over Roth for retirement contributions, unless the options are horrible.
- If you can't afford to max out your Roth IRA with retirement contributions, you might still want to consider it for your emergency fund. The theory behind using a Roth for your emergency fund is that in the worst case, you can pull your contributions out at any time. So, if over a few years, you contribute $10,000 in e-fund to a Roth, you can withdraw that $10,000 no problem. You can't withdraw earnings the same way, but they'll be fairly minimal (since the emergency fund would be conservatively invested). However, if you don't have a big emergency, then you've increased your available Roth space. You can't put that $10,000 back, unless you happen to have that money back within 60 days; then I believe you can call it a rollover if you put it in a different Roth IRA. (Maybe the same one is allowed?) You're allowed one of those per 12 months.
- If you put any emergency fund money into a Roth, don't invest that in stocks; use a short-term bond fund (or an intermediate-term bond fund at most) to start with. If you eventually overfund your emergency fund by about 30%, then switching to a 40% stocks, 60% bond LifeStrategy fund would work. (See this for an explanation of the concept, though again, I'd use Vanguard Lifestrategy fund rather than paying more money to Betterment for the same allocation: https://www.betterment.com/blog/2013/08 ... -is-wrong/)

MathWizard: The OP's link talks about the 7% as a crediting rate. That, to me, makes it sound like the 7% is guaranteed in the present. If it changed to 0% in the future, one could just re-allocate to a new investment option. This would be the same as if a savings account, EE savings bond, etc. was presently offering 7%.

Allan12
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Re: Guaranteed 7% return too good to be true??

Post by Allan12 » Sat Mar 01, 2014 9:00 pm

Yes, the current rate is 7%.

Have a relative that is a NYC teacher.

My thought is to max out the TDA with as much as possible guaranteed at 7% and reevaluate the next time the rate changes, if it does.

The TDA is also great since if you retire at 55, you can withdraw without a penalty, since you separated your service.

z3r0c00l
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Re: Guaranteed 7% return too good to be true??

Post by z3r0c00l » Sat Mar 01, 2014 9:30 pm

My elementary school teachers retired as millionaires off the TDA. It used to be 8%. It is one of the best deals in the investing world today. Helps compensate for only moderate pay, and a job that is, let's face it, stressful at times.

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White Coat Investor
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Re: Guaranteed 7% return too good to be true??

Post by White Coat Investor » Sat Mar 01, 2014 10:20 pm

7% guaranteed? That would be a significant portion of my asset allocation.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Dale_G
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Re: Guaranteed 7% return too good to be true??

Post by Dale_G » Sat Mar 01, 2014 10:31 pm

It would be 100% of my allocation.

Dale
Volatility is my friend

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sunnywindy
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Re: Guaranteed 7% return too good to be true??

Post by sunnywindy » Sat Mar 01, 2014 10:38 pm

If you look at the Fund Profile document (page 13), the ER for the Fixed Return Fund is.....ZERO! "No administrative or fund management expenses apply against the Fixed Return Fund." I agree with other poster that the Fixed Return Fund is one of the specific perks to keep you retained and happy at your (stressful) job, so I would recommend taking advantage of it.
Last edited by sunnywindy on Sun Mar 02, 2014 12:30 am, edited 1 time in total.
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Stan Dup
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Re: Guaranteed 7% return too good to be true??

Post by Stan Dup » Sun Mar 02, 2014 12:11 am

deikel wrote: - AA: Skip the target funds or any % in bonds at this time. Bonds are currently dismal in return and you have so many years to come....no reason to have bonds (aka cash) sitting around idle and not working for you. Yes the market could crash tomorrow, but really if you dont think the market will recover within 30yrs, you should not invest in stocks at all - bonds come into play later in life when you dont want to loose your money when the retirement goal is in sight.
-
]


I don't think this is very good advice at all. You should always have some money in bonds. When markets are good it is easy to be risky. It has only been five years since 2008. How did you react to losing 50% of your equity in a short amount of time? The boglehead method always has some money in bonds. There are other good reasons, (like "dry powder" for rebalancing, and others). You should study carefully before avoiding bonds entirely.

BTW: how can a slight drop in bond value be "dismal in return"? Your stocks drop in far bigger increments on a regular basis and you never give it a second thought, do you?
"The tyranny of compounding expenses is the eighth deadly sin." - George Sisti

Brian2d
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Re: Guaranteed 7% return too good to be true??

Post by Brian2d » Sun Mar 02, 2014 12:29 am

Absolutely take advantage of the TDA. One great perk of being a NYC teacher.

This is one rare case where it's not too good to be true.

BTW if you can hold your fixed allocation in TDA absolutely no need to hold any other bond funds. The debate here about whether or not people should hold bonds is skewed drastically by the 7% TDA option.

letsgobobby
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Re: Guaranteed 7% return too good to be true??

Post by letsgobobby » Sun Mar 02, 2014 1:18 am

Dale_G wrote:It would be 100% of my allocation.

Dale
and mine, too.

You are right that it is too good to be true; but it's too good to be true for those paying the 7% investment return, not for you as an investor. For you it's better than sliced bread.

hellobogle
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Re: Guaranteed 7% return too good to be true??

Post by hellobogle » Sun Mar 02, 2014 6:51 am

Thank you very much for all of the advice, but I think I am even more confused now.
So if I go all fixed in the 403b, then is there a better choice for the Roth IRA?
I like the idea of the automatic rebalancing, but maybe it would eventually be cheaper to just do a 500 index with no bonds since the Fixed Fund in the 403b counts as bonds. I'm planning on getting to $10,000 by the end of this tax year (April 15th, 2015). Still, how do I rebalance with only one fund? It seems easier to just stick with the Target Retirement fund, but am I losing out? .18% is over three times .05%! I would like to make the decision now and stick with it instead of constantly changing funds.

madbrain
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Re: Guaranteed 7% return too good to be true??

Post by madbrain » Sun Mar 02, 2014 6:56 am

Brian2d wrote:Absolutely take advantage of the TDA. One great perk of being a NYC teacher.

This is one rare case where it's not too good to be true.
So how is the TDA able to guarantee such rate ?
Is this one of those deals where it will behoove on the taxpayers to make up the shortfall if they can't ?

dbr
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Re: Guaranteed 7% return too good to be true??

Post by dbr » Sun Mar 02, 2014 8:37 am

madbrain wrote:
Brian2d wrote:Absolutely take advantage of the TDA. One great perk of being a NYC teacher.

This is one rare case where it's not too good to be true.
So how is the TDA able to guarantee such rate ?
Is this one of those deals where it will behoove on the taxpayers to make up the shortfall if they can't ?
Evidently this is not an investment that makes such a return but a compensation package that pays out from funding obtained, ie taxes. That does not have to be an unreasonable arrangement depending on what the compensation system as a whole looks like, meaning the regular pay compared to similar positions elsewhere, the rest of the benefits package, work conditions, and so on. It is unusual.

ASUGrad
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Re: Guaranteed 7% return too good to be true??

Post by ASUGrad » Sun Mar 02, 2014 9:18 am

Well if you have 7% guaranteed you really don't need bonds at all. The risk/return trade off isn't there.

Stocks have the potential to earn more than 7% but obviously there is added risk. If you were 50 I would say the risk return trade off wasn't high enough and you should be 100% in the 7% fund. However you are in your 20s. Stocks go up and down from year to year, but even with that over a long time horizon you should expect 6-8% returns with the possibility of averaging 9-10%.

I'm very aggressive but even I couldn't turn down guaranteed 7% being a significant portion of my portfolio. If it was me(and we are about the same age) I would go 50% guaranteed fund, 50% stocks. The stock portion would be 70-75% domestic, 25-30% international. Logic: if stocks return less than 6% returns over the next 40 years we are going to have much bigger problems and that 7% is likely going to go down as well. If we have 6% you average 6.5% and this is the less likely scenario. If stocks average over 7% you come out better. Even averaging 8% doesn't seem like that much more but compounded over a long time horizon 1% can make a huge difference. Also as a young saver you benefit from volatility in the stock market thanks to dollar cost averaging. Actually after any significant sell off(10% or more) I would probably scale to 75% stocks to capture the eventual rebound and then scale back to 50/50 any time the market hit a new record(like now).

In addition if that 7% drops you will already be use to stocks and could shift more into stocks at that time.


2. I get the logic, but what would it be invested in? If you are invested in stocks now you don't have a 3 month emergency fund, you have a 1.5 month emergency fund because stocks can drop 50%(technically more but unlikely). Also if your emergency happens during a recession(most likely) you are selling at a loss. Better off keeping the emergency fund in a savings account. If there were any decent money market returns in roth accounts I could understand that option, but that doesn't exist right now.

3. You don't need bonds since you have that 7% fund. I would just go total stock and total international stock 70/30 instead of a Target retirement fund. That allocation would require 10k invested so until then I would stick with the TR 2050 until you hit 10k since it is 90% stock. To answer the question about changing target dates, no there is nothing preventing you from doing that. You just exchange from one fund to the other.

4. If you have the money make a lump sum investment. You are still dollar cost averaging, you are depositing roughly the same amount in each year. So you are dollar cost averaging by year instead of by month. Dollar cost averaging benefits when the market goes down then up again, but most of the time markets are going up so most of the time wouldn't you want more money already invested and growing?

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Aptenodytes
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Re: Guaranteed 7% return too good to be true??

Post by Aptenodytes » Sun Mar 02, 2014 9:19 am

hellobogle wrote:Thank you very much for all of the advice, but I think I am even more confused now.
So if I go all fixed in the 403b, then is there a better choice for the Roth IRA?
I like the idea of the automatic rebalancing, but maybe it would eventually be cheaper to just do a 500 index with no bonds since the Fixed Fund in the 403b counts as bonds. I'm planning on getting to $10,000 by the end of this tax year (April 15th, 2015). Still, how do I rebalance with only one fund? It seems easier to just stick with the Target Retirement fund, but am I losing out? .18% is over three times .05%! I would like to make the decision now and stick with it instead of constantly changing funds.
I think you want to be all equities in your IRA. that could be a single fund or a combination. If you opt for a single fund you never have to rebalance. Target date funds would not work in your circumstances though if you choose the farthest off date you won't be in Horribly bad shape because the bond fraction will be low.but any money in bonds is essentially throwing several hundred basis points down the drain.

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tfb
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Re: Guaranteed 7% return too good to be true??

Post by tfb » Sun Mar 02, 2014 8:03 pm

dbr wrote:Evidently this is not an investment that makes such a return but a compensation package that pays out from funding obtained, ie taxes. That does not have to be an unreasonable arrangement depending on what the compensation system as a whole looks like, meaning the regular pay compared to similar positions elsewhere, the rest of the benefits package, work conditions, and so on. It is unusual.
Unusual because the compensation is only paid to those who choose this fund and proportional to the amount such employees put into this fund. Those who don't know to choose this fund lose out on the compensation.
Harry Sit, taking a break from the forums.

dlw322
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Re: Guaranteed 7% return too good to be true??

Post by dlw322 » Sun Mar 02, 2014 9:09 pm

This is one of those things that is not "too good to be true" I was a NYC employee back when the guarantee was 8.25%. I put as much money as I could into it back then. I remember people telling me that I was crazy back in the 90's to be taking the guarantee of 8.25% when they were making tons of money in the market, then the dotcom bust happened....I still continued contributing to the 8.25% guarantee, and again in '04 & '05 before I retired people starting telling me I was nuts again...we all know what happened again.

Take the guarantee it's legit

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