Monday, April 4, 2016

Taking Stock of your QA Career and Retirement

I have talked with several coworkers over the years and all of us have felt at times like it is unclear how to invest for retirement.  Before I go on, I want to assure you that this will not be an advertisement for a particular stock nor will it be US centric with advice on 401k and IRA plans.  Anything I say here is not financial advice, so please do see a professional. To be clear, believe nothing said in this post but rather that you should test all this out yourself.  Use your skills in testing to analyze the data, create mind maps, and don't trust just one source.  I will point out some common heuristics we use in testing that you can apply to the problem.  Your own future is at stake, and at the very least you should approach this problem with equal fervor as you approach your day-to-day testing challenges.

My Experience With Fees

When I started my career in QA at 18 I knew people said I should invest in the stock market, but I was only making a little over minimum wage for 30 hours a week.  I had no money to invest.  By 24 I had changed jobs and was making a better wage, but I had no time to look into how to invest in stocks.  So I used my company’s small compensation, which invested an additional dollar for every dollar I invested, up to 3% of my salary.   Then the housing crisis hit and my very small sum dwindled down to approximately 1,000 dollars.  The investment company was charging me 60 dollars a year in fees, and I felt my money was better off in my pocket than having it spent away on losing stocks and fees.

Now, let’s look at this from a QA perspective, using tools like system’s thinking and the scientific method.  I have since examined a lot of historical stock market data and it’s clear there is money to be made.  Hiring out the investing process to someone else can cost a lot of fees.  So let’s develop a test to see if the fees are worth it.   Since the stock market is easier to measure, let’s use that.  Per Wikipedia, the S&P 500 index fund averaged a return of 12%.  I was being charged 6% in fees.  Since that seems high, let’s also see what 1% and 2% fees would look like.  Here is how that would play out in a 10-year period of compound interest:

FeesInterest After FeesStarting Value10 Year End Value
(See this calculator if you want to run your own tests)

So in 10 years, 6% in fees cost 43% of the possible income.  2% costs 16% of your possible income.  When calculated out to 50 years, 2% of fees from 7% interest will cost you 60% of your income!  So fees do matter, due to the magic of compound interest.  Don’t believe me?  Test it yourself!

 As an important aside, please be aware that while the S&P 500 has seen a 12% rate of return, this does not factor in inflation.  Most inflation adjusted numbers I see show 2-3% of the earnings lost to inflation.

Requirements, Stocks and Bonds

In my story, fees were only one factor.  Another big factor was that I didn’t want to take up a lot of time, time I want to invest in testing career and home life. So, one of the clear requirements is that a retirement system for me must be fast and easy to calculate.  Speculation is a form of gambling with high risk and high reward while investing is an effort to decrease risk and while moderately increasing reward.  In testing we are use to trying to find high-risk areas to investigate and we can use that skill to decide what to invest in and avoid speculation.

With these two requirements, me personally playing the stock market as a day trader is out.  Investigating, buying individual stock and holding it breaks my time requirement.  Housing is so variable to location and many other complex variables, that I think it's too difficult to go into in a short post, but the NY Times calculator was helpful for me.  While buying up gold, oil or other commodities is possible; it tends to be a little more complicated than stock.  This too feels more risky and time consuming, which clearly violates my personal requirements.  So, there are only three big possibilities left within the stock market.  There are actively trade funds, index funds and bonds and of course, one non-market option of retaining cash.

Bonds are effectively agreements to pay back loans from large institutions, like governments, so they can build bridges now, and pay back the loan on low interest later.  They tend to not pay much in interest, but are also generally safer than stocks as governments don’t collapse that often.

Stocks are in fact businesses, which mean you actually own a piece of a business; you might own a brick in the building of your favorite restaurant.  So even when the stock goes down, keep in mind the building is not gone, it just means that someone decided that that the building or the brand or whatever was worth a little less.  On average, if the heuristic of history is a guide, the market goes up in the long run.

Then there are index funds, “algorithmic funds”, often meant to represent all or part of the market.  The S&P 500 and even the Dow Jones fall into this category, both picking the largest companies in the market in an effort to represent the market as a whole.  There are even funds that hold every stock in the market.  In effect, these give you the ‘average’ of the market or some subsection of the market.

The last stock market option is an actively traded funds.  These funds hire experts to gauge the market and invest in what they think are the best companies.  Since you are hiring experts, it costs more and thus you have higher fees.  The question is, are they worth the cost?  Can they outperform average?  Or perhaps, flipping it on its head, can you pick a fund manager who can out perform the index fund?  Keep in mind, Warren Buffet from 1994-2014 made about 12.5% interest compare to the S&P’s 9%.

Of course you could choose to not invest at all.  Keep in mind that not investing is not actually a 100% foolproof way of protecting you.  Inaction is still an action.  First of all, you are being taxed on your income, where as in some countries investing is tax deductible.  Furthermore, cash can be hurt by inflation.  Even if all you did was save cash and could save enough, when you retire, your cash will spend down faster due to a lack of interest, putting you at risk of running out of retirement.

In my opinion, unless you have the time, talent and interest, index funds make things much simpler.  Unless your stock manager is the next Buffet, 1-2% fees will be more expensive than the potentially better outcome they might provide.  However, if you’re a numbers expert or you think you know which mangers will make great investments, go for it! Ultimately you should test these assumptions.

How Much Do I Need?

The final piece to this puzzle is how much do you need to save for retirement?  Earlier I said stocks were a good long-term investment, but how long is long term?  Long term is from the day you retire to the end of your life or beyond.   So, will your money last your lifetime?  More interestingly, can you make your money self-sustaining, using the history heuristic as a reasonable guide on returns?  It turns out the second question is actually reasonably easy to test.  Using the several studies on withdrawal rates show that approximately 4% is a safe withdrawal rate assuming the past is a reasonable guide.  And while I admit that nothing is guaranteed, it's a useful starting place. 

With 4% as our “typical” case, we can start with the assumption that 25 times the current expenses will yield you a safe amount of income.  That is to say, if you take out your current expenses from your stocks/bonds, you will take out 4% of the total fund.  These studies often found people would grow multiple times the wealth they start with, but 4% was for the worst year to start retirement and not run out of money.  Keep in mind your taxes, health care, driving and childcare expenses may change when you retire, but in most cases expenses will go down.  So if you use your current expenses, you're likely to have a reasonable safety net.  Obviously this is critical to your retirement, so you’ll want to test this piece carefully with a lot of what if scenarios.  Tour through your retirement with costs of new hobbies or traveling and with some stress tests, such as you have lots of expense for a few years in the beginning, middle and end of your life.

Have you tested your retirement plan lately?

Post Scripts

In writing this post, I did a lot of research, not all of which fit the nice format of an article.  So, in a mostly unformatted way, here are some additional thoughts to consider:

  • Testers often make a higher salary than the average US household income (and often that is a two person working household).
  • The data seems clear, at best only a few people can actively beat the market long term. However, that is a theory that can be put to the test.   Even active fund managers claim that there is a better than 50% chance that a index fund will outperform an active fund, and it is unclear if that includes fees.
  • This is a nice simple explanation of the business cycle and why it exists.
  • The S&P 500 is more an American index.  While I was not researching how Europeans invest, I did run into an interesting article with different investment methods for Europeans, including investing in the US market.  I have no opinion on the validity nor usefulness of this, as this is not a problem I have faced.
One final thing I wish to make clear is I'm not making any profit from this blog post.  I make no endorsement of any particular investment strategy, I simply suggest you do the research now, when it is easier to plan for retirement rather than waiting until it's too late.

For anyone who has made it this far, I do have a query.  I'd like to know, is this content useful?  Is it too far from testing to be of value or does it still feel connected to testing?  Please tell me by writing a comment below.