Roth IRA Challenge: After You’ve Crushed It!

I’m really excited about today’s Roth IRA Challenge! Mr. Groovy is joining us today from over at Freedom is Groovy where he and his wife write about their collective journey to leave the rat race to “Take a Hit of Freedom” (as their blog tagline declares). They are hilarious writers with fascinating, original takes on the same topics we all discuss. Today’s guest post is a perfect example. Mr. Groovy asked if he could do a new twist on the Roth IRA Challenge – what to do with the money AFTER you max out a Roth IRA (“Of Course!” I said. “What a brilliant idea!”). So, he’s here today to give a great guide to investing with an awesome asset allocation tool for all of you! Take it away Mr. Groovy:

When it comes to investing and Roth IRAs, Mrs. Groovy and I were definitely late to the dance. We didn’t open our Roths until 2006, when we were at the ripe old age of 45.

But we had one very important thing to cushion our late start. We were debt free.

In 2006, Mrs. Groovy and I relocated from New York to North Carolina. The profit we made from the sale of our condo was enough to wipe out our remaining consumer debt and pay for a house outright in Charlotte.

Mrs. Groovy and I were thus extremely fortunate. When we finally grasped the importance of saving for retirement, and were eager to check out this Roth thingy, we had no debt, no kids, no costly vices, and no shortage of income (i.e., we both had nice paying jobs). So maxing out our Roths didn’t require a side-hustle. All it took was about a half hour of our time at a local Fidelity office and wallah—$667 was transferred every month from our checking account into our Roths ($4,000 was the contribution limit back in 2006).

“Okay,” you’re no doubt mumbling to yourself. “What the heck does this have to do with the side-hustle challenge?”

Nothing. But if you’re a fan of Maggie, I’m extremely confident that you will soon figure out a way to fund a Roth IRA. And this is where I come in. You need to know what to do with the money you contribute to your Roth.

Here, then, is the wisdom I derived from ten years of awesome investing.

Protect Yourself from You

Stocks are scary. And you know what’s even more scary? You. You don’t know what you’re doing. So you’re going to make mistakes. And that’s okay. Every investor makes mistakes. The trick is to keep your inevitable mistakes from causing catastrophic damage to your portfolio. Let me explain.

Investing in stocks is no more scary than driving on America’s highways and byways. Every driver makes mistakes. And newbie drivers make the most. But even though they know it’s dangerous, Americans still drive. Why? Because we have devised numerous ways to mitigate the threat that you pose to yourself whenever you get behind the wheel. Obey speed limits, wear seatbelts, refrain from tailgating, look before you change lanes, maintain your car (especially your brakes), turn off your cell phone, drive sober—follow these basic practices and the likelihood that one of your mistakes will kill or maim you is very small.

The same thing goes with investing in stocks. There are tried and true ways to keep you from obliterating your savings. Here are four very effective ones that any well-manicured ape can follow.

  1. Don’t buy individual stocks. There are too many unknowns. A war, a natural disaster, a new regulation, a new technology, or a new competitor can turn a surefire stock into crap overnight.
  2. Buy stock funds that own little portions of hundreds of companies. This spreads the risk. You’re not betting on individual stocks or particular industries, you’re betting on the stock market as a whole. And the stock market has far more up years than down years.
  3. Never buy a stock fund that has an expense ratio greater than half a percent. Failing to honor this is likely to make your broker richer than you. Doubt it? Just read the book, Where Are the Customers’ Yachts, and all will be explained. In the meantime, to keep the expense ratios below half a percent, you’ll be limited to index funds and ETFs. And that’s perfectly fine.
  4. Invest the same dollar amount in the same stock funds every month—regardless of what the stock market is doing. This technique is called dollar-cost-averaging, and it’s a great way to make sure you buy stocks when they’re on sale (i.e., when the stock market has stumbled or crashed).

Protect Yourself from Others

“Okay,” I hear you mumbling again. “I see where you’re going here. I can practice safe investing just like I practice safe driving. But what about the threat posed to me by others? I can’t stop other drivers from speeding, or texting, or being stoned out of their minds. Nor can I stop Washington or the one-percenters from wrecking the economy. How do I protect myself from the Wall Street casino?”

I’m glad you asked. Here’s the answer.

Yes, stocks are very volatile. In 2008, for instance, the stock market was down 37 percent. If you began the year with a $100,000 portfolio completely invested in stocks, you ended the year with $63,000. Ouch.

The stock market, however, has an uncanny knack for rebounding after a large sell off. Here is what the stock market returned in the years following the 2008 crash.

  • 2009: 25.94%
  • 2010: 14.82%
  • 2011: 2.10%
  • 2012: 15.89%
  • 2013: 32.15%
  • 2014: 13.52%
  • 2015: 1.36%

The only investors who lost money in the 2008 crash were those who sold. If you held onto your stock funds, and kept putting money into them, you did remarkably well. So one way to protect yourself from dramatic drops in the stock market is to do nothing.

But a lot of people don’t have the stomach for that. They see their stock funds plunging in value and it’s just too psychologically painful. So they sell—thus transforming their paper losses into real losses. Not good.

A better way to protect yourself from the volatility of the stock market is to have a portion of your portfolio invested in bonds.

Suppose for a moment that your portfolio at the beginning of 2008 was equally divided between stocks and bonds. You had $50K invested in an S&P 500 index fund and $50K invested in a bond index fund made up of 3-month treasuries. At the end of the year, your S&P 500 fund lost $18.5K (-37%). Your treasury fund, however, made $795 (+1.59%). You thus began 2009 with a portfolio valued at $82,295. Not great. But certainly better than the $63K you would have had if your entire portfolio were invested in stocks.

Going back to our driving analogy, bonds are like airbags. They are there to protect you from threats you can’t control—other drivers, inclement weather, tire blowouts, and errant deer. If you do get into a car accident, airbags will greatly increase the odds of your surviving. Likewise with bonds. If the market tanks, bonds will mitigate your losses and give you the resolve to stay the course. In other words, you’ll be less inclined to lock in paper losses. Rather than panic and sell, you’ll leave your stock investments alone and allow the recuperative powers of the market to work their magic.

Don’t Use Too Much Protection

Okay, you’ve crushed Maggie’s side-hustle challenge and you’ve set up a Roth IRA with a discount broker. All you have to do now is evenly split your side-hustle money between stocks and bonds, right? Not exactly. To explain why, I’m going to throw another analogy at you. Here it goes.

When you were a kid jumping rope or playing HORSE, did you wear a helmet? Of course not. That would be ridiculous. But when you were up at bat in Little League, did you wear a helmet then? Of course. Not wearing one would be equally ridiculous.

Safety equipment is designed to address reasonable threats. How likely is a kid jumping rope or playing HORSE to get a head injury? It could theoretically happen. But the odds are so remote that no one engaged in those activities bothers to wear one. Baseball is another story. Pitchers do occasionally plunk a batter in the head. So it makes sense to put a helmet on when you get in the batter’s box.

The amount of bonds in your portfolio is thus determined by how damaging a market crash would be to your retirement nest egg. If you’re in your 20s, a 2008-like market crash poses absolutely no risk to your nest egg. You have plenty of time and income-generating years to make your nest egg whole. If you’re in your 60s, however, a market crash could irrevocably damage your nest egg and your retirement goals. Time and income-generating years are short.

So returning to our youthful activity analogy, if you’re in your 20s, you don’t need any safety equipment while playing in the stock market. The stock market for you is the equivalent of jumping rope or playing HORSE. If you’re in your 40s and 50s, you better wear a freakin’ helmet. The stock market for you is the equivalent of playing Little League baseball. And if you’re in your 60s or first few years of retirement, the stock market for you is the equivalent of being a goalie in ice hockey. A lot of hard objects are flying around you with malicious intent. You better load up on safety equipment.

Here, then, is an age-based guide to how much safety equipment you should wear while funding your Roth IRA.

  • 20s: No bonds in your Roth IRA are necessary.
  • 30s: Ten percent bonds.
  • 40s: Twenty percent bonds.
  • 50s: Thirty percent bonds.
  • 60s: At least forty percent of your Roth IRA should be comprised of bonds.

Use My DIY Portfolio Tracker When Things Get Complicated

Finally, I just want to touch on something that took Mrs. Groovy and me several years to figure out. As you get older, it’s highly unlikely that your nest egg will reside entirely in a Roth IRA. You may get a job that has an awesome 401(K) plan. You may get married. And your spouse may have an IRA and an employer-sponsored retirement account as well. Mrs. Groovy and I have six investment accounts. Two Roths, two employer-sponsored retirement accounts, and two brokerage accounts.

Having six investment accounts certainly complicates matters. And to make matters worse, Mrs. Groovy and I didn’t know what the heck we were doing when we began our investing careers. Yes, we had a superficial knowledge of asset allocation. We knew, for instance, that our portfolio should consist of stocks and bonds. But we didn’t know what this split should be. And we didn’t know that stocks and bonds come in a variety of subcategories or classes. Financial gurus we respected said some part of our portfolio of should be in small cap value funds. Others said we should have exposure to emerging market funds. My cousin, who does estate planning for multi-millionaires, insisted that we get some muni funds into our portfolio.

In short, up until four or five years ago, our portfolio was a mess. We had six investment accounts and not one had an international stock fund. The only bond exposure we had was in the target-date funds we parked in our Roths. Our portfolio basically consisted of individual stocks and large cap stock funds, some with high expense ratios and small with small expense ratios. Meh!

Our conundrum was rather straight-forward. We had to get an asset allocation we were comfortable with, and we had to produce this asset allocation across six investment accounts. We needed to get our six investment accounts acting as one unit.

To help with this conundrum, I developed a DIY Portfolio tracker that you can download here.

My tracker is a simple spreadsheet that contains two tabs. The first tab of the spreadsheet is called Portfolio. I use it to list all the various funds Mrs. Groovy and I have in our six accounts.

To give you an idea of how it works, here is a screenshot of the Portfolio tab with some sample data. It shows the stock side of our portfolio and some of the funds we use. Notice how it’s broken down by asset class.

tracker1

Here is a screenshot of the bond side of our portfolio. There’s definitely less variety here. Most of our investments are in intermediate bond funds.

tracker2

To use the Portfolio tab, simply list your investment funds by asset class. If you’re not sure what asset class a particular fund is in, go to Morningstar and enter the fund’s ticker symbol. Here is what Morningstar produced after I entered the ticker for the Vanguard Total Bond Market index fund (VBTLX).

tracker3

If you’re considering investing in another fund or asset class, add it to the Portfolio tab as well. Mrs. Groovy and I, for example, are looking into short term bonds, so we added this class to our Bonds/Cash category. Doing this will help you when you click the next tab in our tracker, the tab which helps you 1) formulate an asset allocation that works for you, and 2) turn all of your various investment accounts into one cohesive unit.

Tab two of my DIY Portfolio Tracker is called Allocation Helper, and this is where the fun begins.

All the information on this tab is based on the information in the Portfolio tab. If I change an asset class—say, dropping my commodity fund and substituting an emerging market fund—that change will automatically be reflected in the Allocation Helper tab (column B). The same goes with the value of my investments. Whenever I update the amounts in my various funds in the Portfolio tab, the total amount invested in a particular asset class is automatically updated in the Allocation Helper tab (column C).

tracker4

Column D is used to show what percentage of a category (stocks or bonds) a particular asset class makes up. Column E shows your desired asset allocation. And column F shows what you have to add or subtract from a particular asset class to meet your desired allocation.

Right now, our sample portfolio is divided equally between stocks and bonds. Let’s suppose that Mrs. Groovy and I decide that that’s too conservative. We’d rather have sixty percent of our portfolio in stocks and forty percent in bonds. And let’s also suppose that we want to drop our commodity assets. We’d rather have that money in real estate. To find out what we’d have to buy and sell to make that new allocation happen, we’d simply plug our desired numbers into column E. Here are the results.

tracker5

Final Thoughts

Whew! I know I’ve thrown a lot at you. But by crushing the side-hustle challenge, you’ve already done the hard part. Remember: you don’t have to become an expert investor overnight. If you’re really nervous about investing, just put your Roth contributions into a target-date fund. Your expenses will be a little higher, but the pros will be making your asset allocation decisions for you. And that ain’t a bad thing. Just keep saving and learning and you’ll be fine. Cheers.

P.S. The link to download the Portfolio Tracker also points to a link for the user’s guide. So don’t worry if you’re somewhat confused on how to use the tracker. The user’s guide will answer any questions you might have.

Disclaimer: This post may contain affiliate links which, at no cost to you, helps support Northern Expenditure and keeps our heat on in the winter. Thanks!

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22 Comments

  1. Great angle on the challenge. This should kick-start a lot of people that hesitate to invest. Great analogy with driving a car.

    • MaggieBanks

      Wasn’t this such a great post? Way to go Mr. Freedom!

    • Hey Ambertreeleaves – That’s my experience. The hardest part is just getting started. Once you start, and work at it, you can become pretty good at it. Thanks for your kind words.

  2. I finally opened my first Roth this year, since I was no longer eligible to contribute to a 401k and that sweet 6% match I got when I worked full time. I opened with Vanguard and I didn’t feel up to deciding where to allocate, so I chose a target date fund. I have a lot of learning to do in the investment department.

    • MaggieBanks

      I hope this helps! (and a 6% match is awesome! I only have a Roth, so I feel you there.)

      • Hey Maggie, It’s a shame Jen can’t take advantage of that 6% match anymore. Mrs. G is extremely fortunate. She has an 8% match at work. It’s practically unheard of.

    • Hey Jen, you’re doing great. Mrs. Groovy and I started out with target date funds. It’s a great default strategy. After a few years of learning we felt comfortable to branch out and away from target date funds. But there’s no rush. When you’re ready, you’re ready.

  3. Really informative and helpful post. I will definitely be bookmarking this for when we can start funding Roth IRA’s instead of paying down debt. Thanks!

    • MaggieBanks

      I’m glad it was so helpful for you! His tool is awesome!

    • Hey Harmony, You’re welcome. I’m honored you think my post is worthy of bookmarking. Mrs. Groovy and I had the same strategy. We got out of debt before investing. Being out of debt makes life a lot less stressful. As an added bonus you can fully fund your Roth. Good luck with your war against debt.

  4. Thanks for sharing. I wish I’d read this post before investing on individual stocks (some were bonus payments but some id selected myself).
    And the portfolio allocation was really interesting as well.
    We came ‘late to the dance’ with kids and 2 mortgages but at least we are here!

    • MaggieBanks

      Better late than never! And I’m lucky I happened upon an article about index funds when we first started investing.

    • Hey Personal Economist – I’m very glad you made it to the dance! Mrs. Groovy and I got out of stocks because we knew we were in over our heads. Fortunately we got out before we got burned. But as long as it’s a very small portion of your portfolio, you’ll be fine. A little gambling is not the end of the world.

  5. Very well done piece with some great advice. Love the spreadsheet, too! Couldn’t agree more about index funds and passive investing. Vanguard is usually the best place to look for the cheapest funds, and with Roth IRAs you have the choice of opening there. Unfortunately 401ks often have bloated fees, but with employer matches they are still a great option. A note of caution, though: the Roth is usually only a good bet if you think retirement spending will be greater than current income. For the frugal minded, often the regular IRA/401k works out to be the better bet, as Go Curry Cracker has explained in detail. But maxing out savingsin any direction will put you well ahead of the curve, so this is a much finer point. Nice job, Mr. Freedom!

    • Hey Mortimer – I’m glad you find the spreadsheet helpful. We certainly do. It’s helped us formulate and maintain an asset allocation strategy that we’re comfortable with. I didn’t realize there was a possible downside to the Roth IRA. Thank you for that link to Go Curry Cracker. I’m a big fan of Jeremy’s too. I’ve added that article to my weekend reading list.

    • MaggieBanks

      I agree with the maths, Mortimer. But then there’s the feelings…. 🙂

  6. Enjoyed the article Mr. Groovy. In particular the bond analogy to safety equipment and the recommended bond allocation by age group.

    Maggie, we just discovered your blog about a week ago, but we’re already fans. Looking forward to following your journey.

    -J&D

    • MaggieBanks

      Well welcome to the blog! I’m glad Mr. Groovy was here to welcome you! 🙂

    • Hey, BF. Thank you for your kind words. I really appreciate it. And you are so lucky to have discovered Maggie’s blog. Mrs. Groovy and I discovered it about six months ago and quickly became Maggie-philes. We love the way her mind works.

      • MaggieBanks

        Maggie-philes?! Ha ha ha! You’re too much, Mr. Groovy!

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