What does Jensen’s Alpha* have to do with keeping an emergency reserve, paying off debt, and saving for retirement?

Mother’s Day in Holliston, 2022

Have you ever spent Mother’s Day watching YouTube videos to learn how to calculate the standard deviation of a two-asset portfolio? If you have been wondering why the blog has been quiet, this is the reason. Long time followers will recall a VeryKate post about financial planning. I’ve always been interested in personal finance, and during the Pandemic I found myself listening to daily finance podcasts (Like my favorite Jill on Money). Even when I thought the subject matter didn’t apply to me, I almost always learned something that I could put to practical use. (I’m talking to you, whole life policy I purchased for an infant who now has a child of her own).

Basically, financial planning for most people comes down to three things: make sure you have an emergency reserve fund in a plain old savings account (the Pandemic sure reinforced this); pay off debt (but not your mortgage); and fund your retirement plan as aggressively as you can while still living your life.

So last July I took the plunge and enrolled in the Certified Financial Planning Certificate Program at Boston University. This is a seven course program that I need to finish in 21 months. I’m not sure what I expected the workload to be, but it has been seriously time-consuming. Some of the topics are really interesting, but there is a lot of math. A LOT OF MATH. I barely made it through the math part of graduate school, and I find this even harder because it is all remote learning.

Math

There are some practical applications though. This past winter you could find me snuggled up before a fire reading the terms of our homeowner’s insurance policy. I finally understand it! Information on employee benefits, taxation, and retirement planning have actual work application for me. Also, I am armed with just enough data to hound other people to focus on their finances. I have done a lot of research lately on happiness and work satisfaction, and it turns out that having an understanding of the state of your finances (even if the picture isn’t rosy) leads to lower anxiety and increased life satisfaction. So if I have recently hounded you about your Roth 401K, it is for your own good.

In that finance post from 2019, I made a plan to fully fund my 457 plan by September, 2020. I must report that it took me a little over a year longer than I hoped, and I created a lot of work for our Payroll/Treasury staff by increasing my contribution by $100 – $200 every few months. But I got there!

Then I started learning about the power of Roth plans. Many of us are above the limit to contribute to a Roth IRA, but Roth 401K and 457 plans have no income limit, and we can contribute up to the maximum just like with the traditional pre-tax plans.

I have become convinced of the value of the Roth, especially for young investors. I was always told that the benefit of the pre-tax plan is that we will pay the tax due when we retire and are presumably in a lower tax bracket. For many of us, most notably anyone entitled to a pension, this is simply never going to be the case. Our taxable income is not likely to ever be in a significantly lower bracket. Saving in a Roth Plan requires paying taxes today (at historically low rates, by the way) and our investment will then grow and be distributed completely tax free. Ed Slott, retirement planning guru and author of the The New Retirement Savings Time Bomb, likens pre-tax plans to a loan to the government that you will have to pay when you are no longer working and need the money more than ever.

We implemented a Roth 457 in our town this year (all I had to do was ask), and I allocated all of my future contributions to the Roth. The tax hit hurt initially, but like anything else, you get used to it. Also, I’m 59 (for a few more months) and I am convinced the Roth is still valuable at my career stage. (Again, if you are a young investor, it is a no-brainer. Get on it.)

The key advice our ICMA RC (now Mission Square) expert told us in 2019 is to work to maximize retirement planning early in your career. You can always scale back, or stop altogether, but you can never catch up if you don’t start. My daughter (#1) Molly started maximizing her 457 in 2019 and was able to keep it up for two years. She later scaled it back to pay for daycare, and plans to increase it again incrementally as her financial situation changes. Another benefit to having started saving aggressively early is that the recurring revenue was available to her to reallocate to daycare expenses. (Yes, she recently converted entirely to Roth. I can be exhausting).

So how about you? Are you maximizing your retirement plan contributions? Have you bought into the Roth bandwagon or do I need to have coffee with you to talk you into it? Does your employer offer a Roth option? (If not, will they? Can you ask?) Do you have six months of expenses in an emergency fund? Do you have any idea what your monthly expenses even are? Do you have a plan to pay off debt? What is one thing you can do this summer to improve your financial health?

Let’s practice. It’s spelled R-O-T-H.

*”The Jensen’s measure, or Jensen’s alpha, is a risk-adjusted performance measure that represents the average return on a portfolio or investment, above or below that predicted by the capital asset pricing model (CAPM), given the portfolio’s or investment’s beta and the average market return.” (Investopedia)

Note to Readers: A technical glitch required me to repost this blog. If you received it twice, my apologies.

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