Investing For Your Future
Monthly IFYF Investment Message
September 2005
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Personal finance research studies can help explain how people think and behave regarding their use of money and factors that influence financial decisions. Research results can also provide guidance to investors when making future investment decisions. Below is a summary of five recent studies about retirement planning and investing that have implications for individual investors:
- A 2005 study found that both social and psychological factors increase the likelihood of retirement planning. One such factor was having a positive attitude toward financial advice. Unit 10 of Investing For Your Future (http://www.investing.rutgers.edu) contains information about how to select financial planners and other professional advisors, including questions to ask, compensation methods, and Web sites and phone numbers to obtain referrals.
- A 2000 study analyzed factors that affect a person's planned retirement age. Among the significant factors that were found were financial preparations for retirement, current age, and anticipated life expectancy. The study also found that adjustments to planned retirement age take place over time and that the length of a person's working life is influenced by their health status as well as characteristics of their job. A helpful tool to determine approximately how much savings is needed for retirement is the American Savings Education Council's Ballpark Estimate worksheet available online at www.asec.org.
- Another 2000 study reported on research about retirement planning guidelines. The study used the Delphi research method where a panel of experts was queried in a sequential set of questionnaires designed to facilitate a consensus about this topic. General agreement among the expert panel was found for using a 4% inflation rate, an 8.5% rate of return on investments, and a replacement ratio of 70% to 89% of current income when making retirement projections. The panel did not generally agree with advice that an investor should maintain stock holdings in his/her portfolio equal to "100 minus his/her age" (e.g., 40% for a 60-year old). Only 29% of the expert panelists agreed with this statement. Further information about tax-deferred retirement savings plans, such as IRAs and 401(k)s, can be found in Unit 7 of Investing For Your Future.
- A 2004 study looked at the benefits of international diversification on investment performance to determine if an investor can gain additional diversification benefits by investing in today's increasingly integrated global financial markets. The returns on four different international indexes were analyzed for a 22-year period from 1978 to 2000. The authors concluded that, although the benefits from international diversification are decreasing, an investor is better off investing a portion of his or her portfolio in international markets, especially European markets. An easy way to invest in overseas securities is with an international fund (invests in securities of countries outside the U.S.) or global fund (invests in securities worldwide, including the U.S.).
- Another 2004 study investigated criteria that can be used to select mutual funds that consistently outperform others. The authors found that low cost mutual funds tend to outperform higher cost funds over multiple time periods. In other words, expense ratios (definition: the percentage of a fund's average net assets used to pay expenses, including management fees, administrative fees and 12b-1 marketing fees, if any) turned out to be the best predictor of a fund's over- or under-performance. The authors advise that, based on this finding, investors are encouraged to choose funds based, in part, upon their expense ratio. The lower the expense ratio (e.g., .20% versus 2.0%), the better. Index funds, for example, are known for their low expense ratios. Further information about mutual fund expenses can be found in Unit 6 of Investing For Your Future.