Q&A: Does Market Timing Work?

Can going in and out of the market give you better returns?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: What’s your take on managing one’s 401(k), IRA or taxable account using stock charts — i.e., buying/selling ETFs or stocks based on trends, momentum of stocks, etc.? Perhaps one would not make as much money because of not being fully invested all the time in the market, but wouldn’t this method also keep you from losing large amounts in short periods, especially in bear markets? In other words, I am talking about technical analysis. If I have the time, wouldn’t this be a viable alternative to having a firm such as yours manage my portfolio?

Ric: No, it isn’t a viable alternative. If it were, everyone would be doing it and getting rich. Market timing doesn’t work, and charting/technical analysis, which is a form of market timing, doesn’t work either. You won’t be able to find anyone who consistently and over long periods beats the market that way. I know of no chartist who correctly called the 2008 credit crisis, for example.

The reason it doesn’t work: No system is capable of telling you when to get out and when to get back in. You have to be right every single time, because one incorrect call wipes out every previous correct call.

I’ve never seen any system that has been right most of the time, and even if one existed it wouldn’t matter — because the few times it erred would destroy the value of all the other times that it was right.

Here’s an example: A couple of years ago, a guy bragged to me that he correctly predicted the 2008 credit crisis, and he sold in 2007 when the Dow Jones Industrial Average was still near its high (at the time, around 11,000). I asked him when he got back in, and he said he never did.

So, he made one right call (got out at the high) but then made one wrong call (never bought back in). The result was that he was far worse off than if he had made no call at all: Staying in would have taken him down to a 6,700 on the Dow, but then he would have ridden it right back up again to today’s level of 27,000 — about twice as high as when he made his right call. So being right only once was very costly to him.

Avoid such folly and ignore the slick salespeople who are trying to convince you to engage in it.


Q&A: Can You Outperform a Diversified Portfolio?

online money calculator investment receipts

Maybe, but there’s a few reasons you might not want to try.

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

Question: If, over the long run, the S&P 500 will return 9% or 10% per year, and I have a very long investment horizon (say, 10+ years), am I not better off simply placing my money in an S&P 500 index fund, which will likely outperform a diversified portfolio? Yes, I’m aware of market volatility and the risk that equities can go into prolonged slumps, but even if the investment began in 2007, the return would have been great. What am I missing?

Ric: You’re assuming that a diversified portfolio will earn less than the stock market over long periods. That’s not necessarily true. Keep in mind that a diversified portfolio is designed to reduce risk (volatility), not return.

History shows that in many 10-year periods, a diversified portfolio earns as much as the S&P, but does so with less risk. Meanwhile, many people who claim they can tolerate prolonged stock market slumps discover they really can’t. Just ask all the folks who sold in 2008 as the markets fell.

But if you are certain that you have both a long time horizon — 10 years or more — and a very strong stomach, we have no problem with your owning a pure stock portfolio.

But be forewarned: In our experience, the person who claims to have both turns out have neither.

When that market downturn comes, they realize they don’t have the strong stomach they thought they had, forcing them to sell low, with big losses. Or something comes up in life unexpectedly — a marriage, a child, a job loss or a medical issue — causing their long-term horizon to evaporate. Millions, for example, lost their jobs in 2008, forcing them to sell their investments so they could pay their bills.

They didn’t plan to sell but found themselves with no choice — again, ruining their plans to stay invested for the long term. For these reasons, people who don’t start with a diversified portfolio often later wish they had. Maybe you too.

Investing strategies, such as asset allocation, diversification, or rebalancing, do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Funds and ETFs are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results.

How to Keep Emotions Out of Investment Decisions

My strategy might surprise you.

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

A caller to my weekly radio show once won the applause of the day for asking a question that might be on your mind as well:

“Ric, how have you personally learned to keep emotions out of your investment decisions?”

He found my answer surprising. Perhaps you will too.

“What makes you think I have my emotions under control?” I replied. “As a matter of fact, I’m not able to avoid emotional reactions any better than you are.”

This might seem shocking. After all, I’ve been a financial advisor for more than 30 years, and tens of thousands of people rely on me and my firm to manage their investments. So, what does it mean if I can’t manage my own emotions?

Think back to 2008, when the stock market was falling 65 percent in value. I’m sure you were scared. And so was I — how could anyone not have been frightened? But instead of selling my own investments in a panic or telling clients to do that, do you know what I did? I turned to my colleagues at Edelman Financial. We met frequently to evaluate the latest economic news and market activity, and we discovered that these group sessions created vital support for each other: When one of us was feeling shaky, others helped provide reassurance. It was almost like grief counseling.

And this was vital — because our nervousness maximized when we each started thinking about our own personal accounts. But when we focused instead on the firm’s asset base, our emotions were removed. As a firefighter once told me, “When I arrive at the scene, people are always in a panic. But I never am. After all, it’s their crisis — not mine. And becoming panicked like them doesn’t do anyone any good. So, I just go about my job, and we get through the crisis as quickly as we can, minimizing the damage.”

A similar thing happens when a loved one dies. Everyone is sad, but not everyone collapses in sobs at the same time. One moment finds you hugging a loved one; then later someone is hugging you, offering welcome and needed assurances that you’ll get through it. That’s how I and my colleagues at EFS got each other — and our clients — through the emotional stress of 2008: We relied upon each other.

And we had much more than mere emotional support to help us. We didn’t get through the crisis by singing Kumbaya, hugging each other and saying, “there, there.” Instead we gave each other an as-needed Cher-slapping-Nicolas-Cage admonition to “SNAP OUT OF IT!” along with a reminder that our disciplined investment management approach would help enable us and our clients to weather the storm. Indeed, our extensive diversification and strategic rebalancing while maintaining a long-term perspective were precisely what helped us maintain focus, and they were precisely what we were doing.

Yes, my calm colleagues were able to reassure me that our investment management program — which I’d designed, by the way — was going to help get us through the crisis. So I told myself to relax and get back to the business of reassuring our clients.

I’m not smart enough to beat my emotions. Instead, I’m smart enough to know that I can’t beat them. So I enlist support from others. And that’s what we encourage our clients to do: When you’re nervous, don’t sell in a panic like many others do. Instead, call us. We’ll help you get through it.

The message is clear: Rely on an advisor. But you must make sure that your advisor has two vital attributes: a disciplined investment approach and the experience to know how important it is to stick with it during difficult times.

If your advisor had no disciplined investment approach — if all he or she has done is sold you a bunch of investments that you were willing to buy — and if he or she didn’t go through the crash of 1987, the panic of 1994, the tech bubble of 2001 or the terror attack of 9/11 — then he or she may panic as much as you. And as our firefighter friend taught us, having two panicking people doesn’t lead to good outcomes.

Many people went through 2008 either without an advisor or with one who left them no better off than if they had been alone. In their panic they sold their investments, often at huge losses. These people are clearly acting as their own advisor. But as the adage says, a doctor who treats himself has a fool for a patient.

So are you when dealing with your own money. That’s why we’re all better off talking with an experienced advisor — one who can be objective when we’re not.


Do You Think the Stock Market Will Rise or Fall?

Your answer might depend on when the question is asked.

Think for a moment before you answer the following question: What are the odds that the stock market will fall at least 12% in a single day at some point during the next six months?

After pondering this question, perhaps you conclude this happens occasionally. Would you say there’s at least a 10% chance?

That’s what a majority of investors said when the Yale University School of Management posed this question during a study in 2016. Based on that and related data, the Yale researchers concluded that investor pessimism about the stock market was at its highest in three years. The study was conducted in the middle of February — when the stock market had fallen more than 10% since the beginning of the year.

The researchers noted that people’s predictions about what’s likely to happen next in the market are often mere extensions of what has just happened. In other words, many investors’ forecasts are really “after-casts” — simple projections of the recent past into the future. We call this behavioral finance phenomenon recency bias.

Words charged with negative emotion — media favorites are “crash” and “plunge” — also play into this. You may remember reading or hearing those words during the first six weeks of that year. Because the market fell 10% during that period, many people likely assumed that week #7 would follow the same pattern. Instead, during the next four weeks, the S&P 500 Stock Index rose 11% — gaining back the previous losses. Had the study been conducted at that point, perhaps it would have found that investors were more optimistic than they had been.

If you think the stock market might fall 10% within six months, you should know that history says it’s very unlikely. In the 87-year period from 1929 to 2015, there were 174 six-month periods. Drops of 10% or more occurred just 1% of the time, according to the Yale finance professors.
The study also found that professional investors — including active managers of mutual funds — tend to exaggerate the odds almost as badly as individual investors do.

So instead of allowing feelings of optimism or pessimism to influence your investment decisions, the best course is to maintain perspective. Trust the statement printed on the front page of every mutual fund prospectus: Past performance is no guarantee of future results. Any assertion to the contrary is a federal offense. Don’t assume that what happened in the past week, month, quarter or year is predictive of what will happen next.

Instead, here’s how to manage your assets wisely and effectively: Invest in a highly diversified manner, maintain a long-term focus and rebalance your portfolio as warranted.

An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results.

Market Summary: August 2019

Stocks close a volatile month down.

What happened.

August was a volatile month in stock markets around the world.  Large-cap stocks, measured by the S&P 500 Index, moved by over +/- 1 percent on 11 of the 22 trading days.  By the end of the month, all the major classes of stocks had fallen.  At home, large caps were down by 1.58 percent and small caps by 4.51 percent (S&P 500 and 600 indices).  International stocks were also down: developed-market stocks fell by 2.59 percent and emerging-market stocks by 4.88 percent (MSCI EAFE and Emerging Markets indices).  Interest rates were also down for the month, boosting bond prices, which rise when interest rates fall.  The Bloomberg Barclays Aggregate Index rose by 2.59 percent.

Why it happened.

One word defined the month in the markets:  trade.  As threats of tariffs, and then signs of international cooperation, bounced back and forth between the US and China, stocks lurched up and down.  In this month’s sidebar, we look at the effects of tariffs on consumers and companies.  Stocks respond negatively to the prospect of tariffs because they may eventually harm companies’ earnings.  On days when the news reported that tariffs were more likely, stocks fell, and on days when negotiations seemed likely, they rose.

Other factors affected markets in August.  The prospect of a global economic slowdown unsettled stock markets.  But signals that central bankers around the world would respond by lowering interest rates to strengthen their economies helped markets.  These signals also led interest rates to decline to unusually low levels:  the US Treasury 30-year yield (the rate the US government must pay to borrow for 30 years) fell to a record low.  Meanwhile, there was some solid data on the US economy, with unemployment at record lows and continued strength in consumer spending providing support for the overall economy.

What this means for you.

At Financial Engines, we build a portfolio tailored to your situation and preferences.  Your portfolio will probably have seen a negative return in August.  The higher the risk of the portfolio—which means a higher share of your portfolio invested in stocks—the more negative the return will have been.  With a lower-risk portfolio, you will have been less affected by the fall in stocks and will have benefited more from the rise in bonds.  It’s always good to use months such as August to make sure you’re comfortable with the amount of risk you’re taking in order to achieve your retirement goals.  What will happen in markets is unpredictable, but you can choose how much risk you are willing to take with your portfolio.  Log into your account or speak to your advisor to reassess how much risk you’re taking and make any necessary adjustments.

©2019 Edelman Financial Engines, LLC. This publication is for informational purposes only and does not constitute investment advice or an offer to buy or sell any security. Future market movements may differ significantly from the expectations expressed herein, and past performance is no guarantee of future results. Edelman Financial Engines assumes no liability in connection with the use of the information and makes no warranties as to accuracy or completeness. Future results are not guaranteed by any party. Financial Engines® is a trademark of Edelman Financial Engines, LLC. Advisory services are provided by Financial Engines Advisors L.L.C. Call (800) 601-5957 for a copy of our Privacy Notice. Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith. All other intellectual property belongs to their respective owners. Index data other than Bloomberg is derived from information provided by Standard and Poor’s and MSCI. The S&P 500 index and the S&P SmallCap 600 Index are proprietary to and are calculated, distributed and marketed by S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC), its affiliates and/or its licensors and has been licensed for use. S&P®, S&P 500® and S&P SmallCap 600®, among other famous marks, are registered trademarks of Standard & Poor’s Financial Services LLC, and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. ©2019 S&P Dow Jones Indices LLC, its affiliates and/or its licensors. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used to create any financial instruments or products or any indices. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages.
An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results.

There’s No Good Excuse for Neglecting This Financial Step

You don’t have to do it by yourself — just make sure it gets done.

Excuses, excuses. We all have them from time to time when we fail to do something we know we should do. Some excuses are legitimate, but most don’t stand up to scrutiny.

That’s especially true when it comes to one of the most important components of sound financial planning: acquiring enough life insurance to make sure your loved ones are protected if you die sooner than you expect.

You probably enjoy talking about investing, seeing your money grow, buying homes and cars, sending children to college, having enough to retire comfortably — but all of that is built on one basic assumption: that you will be alive to do and enjoy these things.

But what if you’re not? Will your spouse, partner or children be able to experience all that you hope for them? Making sure they can is what life insurance is all about.

Yet ownership of life insurance is at a 50-year low, according to the Life Insurance Marketing Association, which says that one in every four U.S. households has no life insurance, including 11 million households with children under age 18. And in 40% of households with children under age 18, the mother is the sole or primary wage earner. Women who own some life insurance have only 69% of the average coverage on men. Equally worrisome is the fact that the average amount of coverage for U.S. adults has dropped to $167,000, down from $300,000 a decade ago.

Lack of awareness isn’t the problem. According to the Life and Health Insurance Foundation for Education, 93% of Americans believe it’s important for people to own life insurance, and nearly 50% admit they need more coverage! That’s like saying, “I know I need it, but I’m not going to do anything about it!”

There are three reasons (excuses) people cite when explaining why they haven’t gotten the coverage they know they need, says LIMRA. Do any of these apply to you?

1. “It’s too expensive.”
2. “I just haven’t gotten around to it.” (procrastination)
3. “I don’t know enough about it to buy it.”

Are any of these excuses valid? Let’s see:

If you believe life insurance is too expensive, I ask you: compared to what? A big-screen television? Well, life insurance is a necessity, not a luxury. And it’s never been more affordable. Prices are at least 50% less than they were a decade ago. A 40-year-old, nonsmoking male in good health can buy a $1 million, 20-year, level-term policy for $73 per month. A healthy, nonsmoking female of the same age would pay even less.

If you have been procrastinating, consider this for your tombstone: “Here lies ________. His family is destitute because he was lazy.”

And if you think you don’t know enough about life insurance, well, that’s what independent financial advisors are for. You only need to know that you want the coverage for your family. They’ll help you do the rest — including figuring out how you’ll pay for it, if you’re not sure you can afford it. (See excuse #1.)

You need to protect your spouse, partner and children. September is Life Insurance Awareness Month — a good time to talk to a financial planner about your need for life insurance and how to get the coverage you need at the right price.

Originally published in Inside Personal Finance September 2015

Should You Lend Money to a Family Member?

Don’t unless you are ready to sue

Like most people, you’d do just about anything for a family member. But what if a family member wanted to borrow money? Should you do it?

No — unless you are prepared to sue that family member.

Lending money to a family member is one of the quickest and surest ways to damage your relationship with that person. If the person can’t or won’t repay the loan, you’ll begin to resent him. If the person is a member of your side of the family, your spouse may begin to resent you. If you start to pressure the person for the money, he will avoid you. Other family members can become unwittingly caught in the middle, and before you know it, family gatherings become rife with tension.

And if the emotional implications aren’t enough, consider this: The only reason the person is asking you for money is because he couldn’t obtain a loan from a traditional source, such as a bank or credit card company. If these organizations don’t consider him worthy of getting a loan, why should you?

Get It in Writing

If you are still not deterred, then at least make sure you lend the money the proper way. This means you must handle the transaction as you would with a stranger. You must draft a loan agreement that will be signed by both parties. If the borrower is offended, or claims that your desire to put it in writing demonstrates that you don’t trust him, do not lend him the money. Any honest and reasonable borrower would be happy to sign a loan agreement. If they plan to pay you back, they will be happy to say so in writing. By the same token, anyone who is insulted over a request to commit to the transaction in writing never intends to pay you back at all.

In the agreement, state:

  1. The amount of money that is being lent. State this in numbers and letters, to avoid claims of miscommunication. Don’t just write $5,000. Print “five thousand dollars and no cents” on the document as well.
  2. The date the money is to be lent and returned. Be specific. “Sometime next year” or “after college graduation” doesn’t work. What if he never graduates?
  3. The interest rate you are charging for the loan. Yes, you must charge interest on the loan. Family members are allowed to charge rates below current market rates, but the IRS requires you to charge some rate of interest — and it must be reasonable. If you lend the money at no interest, the agency will consider the loan to be a gift — making you (the lender) liable for gift taxes.
  4. This gets even trickier if you lend a family member money to buy a house. Take John, for instance. He lent his son, Tim, money to buy a house, but he failed to charge interest. The IRS made John pay income taxes on the interest he didn’t get from Tim (but which he should have gotten), and because he should have paid interest, Tim was granted a tax deduction on the mortgage interest he never actually paid! To the IRS, it didn’t matter that Tim borrowed the money interest-free; he should have been paying interest, so he got the break anyway. Go figure.
  5. The payment schedule that the borrower must follow. State whether you will require periodic payments or a balloon payment, or some combination. Some examples:
    • Monthly payment of principal and interest. This is called an amortized loan, and works like your auto loan or home mortgage. In the early months, most of the payment is interest, with the bulk of the principal being repaid in the final months. Defaulting during the term of the loan means the borrower still owes most of the money he borrowed.
    • No monthly payments. The full loan and all interest are to be repaid at the maturity date. This is good when borrowers have little money or income now, but it’s a higher risk for the lender, since it requires the borrower to come up with a substantial amount of money at a later time.
    • Monthly payments of interest only. Known as a “balloon” loan, this is a hybrid of the above two. The monthly payments are smaller than the first example, but the final payment is smaller than the second example.
    • Or some other combination of the above. Just make sure it’s clearly spelled out in the document.
  6. Penalties for not meeting the above terms. You must state what the penalties are for missed payments and bounced checks. State the grace period, and then make sure you assess the penalty. Failure to abide by the rules of the agreement could cause the IRS to conclude that it is not a true loan agreement.

If the borrower doesn’t pay you back, you are entitled to take a tax deduction as a “bad debt” on your tax return. But in order to win this deduction, the IRS wants to know that you’ve tried everything to get the money back — which may include taking the borrower to court. Are you prepared to sue a family member? If not, then you are not likely to be able to take this deduction.

Clearly, lending money to family members can be treacherous. If you are willing to do it when approached by a family member, the first thing to say is, “If we are to proceed, this must be handled as an arms-length transaction, as though I were a bank and you were the customer. I’m going to charge you interest and demand timely repayment — and everything will be in writing. Are you willing to accept these terms?”

If the borrower is not, then let him go elsewhere for the loan.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.

The Most Important Chart on Investing You’ll Ever See

Understanding the ups and downs of the stock market.

Here is a basic truth: stock prices rise and fall. Of course, literally speaking, this statement is true. But it’s misleading. That’s because the statement is incomplete; it’s not really accurate to say that stock prices ”rise and fall.”

Oh, sure, on any given day, prices might rise or fall. But over long periods, it’s more accurate to say that prices in the overall stock market rise a lot but fall a little, as shown in the image. This chart clearly shows that when  prices are rising, they rise a lot and for a long time. When prices fall, they fall a little and for a short period. This explains the real reason why the stock market is able to exist.

Think about it. If stock prices were to only rise and fall, there would never be growth in the economy. It would force investors to decide when to buy and when to sell.

Imagine playing with a yo-yo. It goes down, then it comes up. Down, up. Down, up. If that yo-yo were a stock’s price, the trick would be to catch it and release it at the right time. But as the chart shows, investing in the stock market is like playing with a yo-yo while climbing a hill. Even though the yo-yo is still going down, up, down, up, the height of the yo-yo is constantly climbing, thanks to the hill’s incline.

Here’s another way to put it: The market doesn’t simply go up one point and then down one point. Rather, it goes up two points, then down one point. Then it goes up four, down one, up three and down one. Sure, sometimes the down is larger than the previous up, but over long periods, the stock market has always produced net profits. That’s why it’s wrong to be upset when stock prices fall. Instead of lamenting the current decline, focus on what is about to happen next. This point is particularly important following 2008’s terrible performance.

But if you had the opportunity to invest at the moment of your choosing, where on the chart would you choose? And where are we on that chart right now? When you notice that stock prices are declining, don’t be upset. Instead become excited about what lies ahead.

An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results. Originally published in Rescue Your Money

Should You Buy Travel Insurance?

Yes, but not your parents’ travel insurance.

Remember when airports featured kiosks that let you buy flight insurance? You could buy $50,000 in coverage for a buck or two. The policies were cheap because it was unlikely that the plane would crash. Today, air travel is so safe you don’t see those kiosks at all.

Getting to that island isn’t worth insuring, but the vacation itself still might be. You buy airline tickets and pay for cruises or hotels months before the trip occurs. What happens if you are ill on the day of departure or if there’s a hurricane or a death in the family that precludes your ability to take the trip?

Travel insurance can help protect you. Policies reimburse you for money spent on nonrefundable airline tickets or hotel rooms, protect you from tour operator bankruptcy and arrange for medical services or evacuation if you suffer a medical emergency while traveling. They can even help if you lose your wallet or passport or incur legal problems abroad.

Policies are available through travel agents, online travel sites and travel insurance carriers. Insurance for a $3,500 trip can be as low as $120.

As with all insurance policies, use a licensed carrier. Study what is covered and how reimbursement is determined. And see if you already have coverage through your credit card or insurance company.


Q&A: Setting Up a Savings Plan for Your Long-Term Goals?

Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.

A 4-step plan to help you reach your savings goals.

Question: I’m 24 and my wife is 20. We have a few thousand dollars in the bank, but I would like to seriously start saving for our future — for our retirement, for our kids’ college when we have kids, and for a house. I am contributing 4 percent of my paycheck to my 401(k) at work, and my employer matches that. My wife doesn’t have a 401(k) at her job. How should we go about setting up the most effective savings plan for our long-term needs and goals?

Ric: First, you get the applause of the day for asking that question. Many people your age don’t think beyond their immediate needs and wants, but because you’re focusing on your long-term goals I’m sure that you and your wife will be financially successful. Many folks in their 50s and older wish they’d started saving at your age.

Let’s begin with your 401(k). You should increase your contribution to at least 10 percent — and to the maximum as soon as you can. Your wife should open an IRA in her name, where she can contribute $5,500. I would also urge her to consider finding a job with a company that offers a 401(k) and matches contributions like yours does. People often fail to realize that 40 percent of compensation is noncash — benefits like health insurance, paid vacation and retirement plans. If your employer isn’t offering those benefits, move to one that does.

Step 2 is to eliminate credit card debts if you have any. After you do, move to Step 3: Create cash reserves. I’d want you and your wife to maintain enough cash on hand to cover at least a year’s worth of spending — to tide you over in the event of a job loss or major unforeseen expense. Finally, Step 4 is to start investing in a diversified, long-term portfolio for the house you want and for college for your future children.

That’s the four-step process, but I cannot overstate the importance of saving for retirement first and foremost. That’s often shocking to folks in their 20s, because it’s hard for them to envision their retirement. Their priorities — after they get past Friday night beer — tend to be buying a car, buying a house, having kids and paying for college, usually in that order.

But the most powerful weapon you have for saving for retirement is time. You now have 40 years to save. If you squander some of those years and delay saving until you’re in your 30s, 40s or 50s, you won’t accumulate nearly as much money as you will need. That’s why I consider this Step 1, with the others lined up behind it.