Are you saving enough for retirement?

This video asks an important question, one that we asked our readers some time ago (and, will answer tomorrow).

It also seems to indicate that roughly 8% is a safe withdrawal rate, at least for men who choose to retire at the standard retirement age in the USA … we’ll explore this further, through a series of posts beginning later on this week.

For now, what do you think is a ‘safe’ % of your Number to live off each year?

So, who’s missed the point?

Philip Brewer, a freelance writer for Wisebread (I presume, amongst others) has had a couple of mentions here, lately; this one for a comment that he made on his review of the book: Your Money Or Your Life [AJC: snappy title]:

The book has a very simple investment program that many people have taken issue with. The authors want you to invest your surplus money (a growing amount, once you make some progress on maximizing income and minimizing expenses) in long-term treasury bonds. More than a few people have criticized the program on the grounds that a diversified stock portfolio would produce higher returns. These people have missed the point: The goal of the investment portfolio is to produce a very secure stream of income. Long-term treasurys are a perfect choice.

Since I haven’t yet read the book, I can only say that I disagree if the authors – hence Philip – were talking about investing for retirement; after retirement – Making Money 301 – I wholeheartedly agree that the “goal of the investment portfolio is to produce a very secure stream of income.”

I also agree that “Long-term treasurys [sic] are a perfect choice”, especially if they are inflation-protected (e.g. TIPS in the USA), and perhaps laddered in some way; alternatively, you could try:

- income producing real-estate purchased in whole or in large part for CASH,

- index funds (although, you open yourself up to a certain volatility),

- Covered calls, perhaps protected by PUTS (if the option pricing allows).

But, not when you are still trying to build up your nest-egg unless you have such a low required annual compound growth rate (which probably means that you came by the page accidentally and are about to click off, never to return) that bonds / treasuries will do the job.

Until you do get within a few years of retirement, the goal of your investment portfolio is simple: it should be to produce your Number

Will a million dollars be enough when I retire?

It seems like we have visited this question a lot … on the other hand, we have new readers every day, so it’s important to revisit the basics – and, I hope, it never hurts us to refresh our point of view either.

So, I couldn’t resist jumping in when Peter of Bible Money Matters posed the question: “Will a million dollars be enough when I retire?”

I told Peter that I love this question because it’s such a loaded one …

… we’d love to BELIEVE that it will be enough, but for most, it won’t.

Why?

Simple mathematics:

If you have $1 million (by the time that you retire in, say, 20 years) and inflation is averaging 4%, then the first 4% of your return goes just to keeping up with inflation. So, now just keeping your money in the bank isn’t enough.

So, let’s say that you can earn 9% on your money (in the stock market … crashes – and, ridiculously high mutual fund fees – aside? Hopefully!), then that’s ‘just’ $50,000 a year after inflation.

But, if you’re retiring in 20 years, $50k is (again, ‘just’) like $25k today [AJC: remember, 4% inflation roughly halves your buying power every 20 years] … so the real question becomes:

Will $25k a year be enough when I retire?

Now, that’s up to you to decide …

… all I can say is that, in my own retirement years, I’m ‘struggling’ to live off $250k a year

Nasty Mr Inflation – Part II

Last time, we looked at dealing with inflation before we retire (a.k.a. Life After Work), to see that $40k a year of current needs means that you need to be able to generate somewhere between $100k and $125k per year, IF you want to retire in 30 years.

Even if we manage to build up the $2.8 million nest egg that Pinyo talks about (or the $1.8 million one that the following reader talks about), we have a problem, illustrated by the comment by Elaine on Pinyo’s post:

I don’t see interest included in the calculations here. Even at 4%, *just the annual interest* on 1.8 million will cover your annual needs. Not that that’s a bad thing, you’ll still have 1.8 mil left when you die. If you plan to use up all your money in retirement the necessary amount would be quite a bit lower.

Elaine has ‘forgotten’ about inflation; this doesn’t stop just because you retire!

You earn 4% on your money and before you get to spend any of it, Mr Inflation ’spends’ 3.5% for you … I asked Elaine if she can live off just 0.5% of $1.8 Million?

When you retire, if you have your money just sitting in the bank, inflation will simply kill you, financially-speaking.

On the other hand, if Elaine buys a $1.8 mill. rental property (paying 100% cash, forgetting closing costs) the property will increase in value WITH inflation, as will the rents … an inflation-proof retirement (or, she can buy TIPS, inflation-protected government bonds … etc., etc.)

The definition of insanity …

“Insanity: doing the same thing over and over again and expecting different results.”  Albert Einstein

Thankfully, this blog isn’t for everybody … only those who want to get rich(er) quick(er) … I’ve proved that it can be done successfully, and I am conducting a ‘grand experiment’ at one of my other sites to prove that it’s not just luck and that others can do it, too.

But, the vast majority are still in the ‘work for 40 years and hope to have saved enough’ mindset … and they have worries of their own, as this recent Gallup Poll showed:

Of course, recent economic woes are probably ‘skewing’ this a little … but, think about it – most aren’t retiring tomorrow, or even in the next 10 years, so markets will have plenty of time to boom and bust again for them.

No, the problem is more endemic: most people simply don’t think that they will be able to retire happy or comfortably – and certainly not wealthy – despite the ‘formidable’ array of ‘retirement weapons’ at their disposal:

So, if the majority of people are using these tools and the majority of people believe that they won’t work for them …

Whatup?!

Surely, at some level, these people know that these tools – as I have been hammering home in this blog for some months now – simply won’t do the job?!

Let’s take a look:

1. 401k’s – High fees; low returns; lousy investment products on offer:

STRIKE 1 – I have never had a 401k and I have no idea what is even in any of my tax-advantaged / retirement accounts.

2. Social Security – An unfunded program; USA in the highest level of debt in history’ what’s the chances of Social Security being around in the same form when YOU retire?:

STRIKE 2 – When my social security statement arrives I chuck it in the trash without reading it, it’s irrelevant, it won’t be around when I retire, and I had this same line of thinking BEFORE I became rich.

3. Home Equity – Please! Where do you intend to live when you retire? By the time you buy and pay changeover costs etc. if you see any spare cash, it may be just about enough to pay off your remaining credit card debt:

STRIKE 3 – I live in my home equity, don’t you?

4. Pension Plan – Do you work for Ford/GM/Chrylser? Any airline? Just about any bank?:

STRIKE 4 [AJC: 4 strikes???!!! I'm an Aussie, what do I know from baseball?] Ditto to the above, in fact, I have never subscribed to an employer-sponsored pension plan, even where I have had the choice.

… need I go on?

The point is, if you know these tools aren’t going to work for you – as the majority of Americans surveyed by Gallup seem to – yet you keep using them – as the majority of Americans do – isn’t that the very definition of ‘insanity’?

Now, that’s a question that I would love to see the Gallup Survey for!?

Looking for the Perfect Retirement Formula?

Conventional wisdom says that you can safely withdraw 5% of your Net Worth each year following ‘retirement’ (hence, the Rule of 20), but conventional wisdom is aimed at people who conventionally retire … which, I trust, is none of us

However, there are essentially two conventional ways of deciding your retirement ‘income’:

There’s the percentage of portfolio method (where you always withdraw the same % of your portfolio each year) and the dollar adjusted method (where you always withdraw the same fixed $ amount, only adjusted each year for inflation).

Colleen Jaconetti, from Vanguard Investment Counseling & Research says:

The percentage-of-portfolio method can give your money a greater chance of lasting throughout your lifetime, while dollar-adjusted gives you a more predictable, inflation-adjusted withdrawal amount each year. If you’re more concerned about someday running out of money, the percentage method may be appropriate, but you’ll need to have some flexibility in your spending.

The percentage of portfolio method tends to last longer, making it more suitable for those of us who intend to retire young … and isn’t that all of us?! Colleen agrees:

If you’re retiring early, such as in your 50s, you may want to start out withdrawing closer to 4% to help reduce the risk of a long-term shortfall.

But, the problem isn’t with the method – in fact, in the first year of your retirement, they produce the same result (it’s only in subsequent years that they vary according to your then-current Net Worth OR according to inflation, depending upon which method that you choose) – it’s with the factor that you choose.

You see, 5% (or even 4%) may be too much!

These ‘common wisdom’ percentages assume average rates of return, but the market doesn’t operate in a line that simply tracks the averages … it moves around the average return randomly …

… and, if it randomly moves the wrong way too early and for too long (pity those who are recently retired) you could easily run out of money in years, not decades!

So, you could instead plug your numbers into a Monte Carlo Simulation (this is a really good one) which tend to produce much more conservative withdrawal rates – more like 2.5% (hence my Rule of 40).

Or, you can go the other way and set up a Bond Laddering strategy that Paul Grangaard claims can support a ‘safe withdrawal rate’ as high as 6.6%.

Do you see our dilemma? A doubling or tripling of life-style (or a similar scale reduction, depending on whether your glass is half full or half empty) depending upon whom you believe.

This is the dilemma that you face when your retirement assets are held in bonds, Index Funds, cash or CD’s … which is why I am trying (actually, failing miserably right now) to live a $250,000 lifestyle on an income and asset-base that actually supports way more than that (I think: I’ll have to wait for the post-meltdown; post-house-purchase; post house-renovation; post-move countries fallout to clear sometime during 2009 to be REALLY sure I’m still living within my means … I think – more likely hope – I am).

So, when I find the Perfect Retirement Formula, I’ll be sure to let you know … Lord knows, if it exists, I need to find it

In the meantime, I have a third method – one that makes the concept of Safe Withdrawal rates virtually irrelevant:

You invest your money in income-producing assets …

… such as, dividend-producing stocks or income-producing real-estate.

You buy the asset with little or no borrowings (which is entirely different to the Making Money 201 strategies that I recommend, but we are now in Making Money 301 – ‘post-retirement’ wealth protection mode – so things change dramatically) and gain the following two huge advantages:

1. You can live off the entire after-tax rent/dividend – with a buffer for holding costs (in the case of real-estate, this could be things like vacancies, taxes, and repairs and maintenance), if required – which is pretty much automatically inflation-adjusted, and

2. Your capital (hence estate) or Net Worth also increases pretty much at least with inflation, as long as you choose your investment/s reasonably well!

No worries about outlasting your income … and, you get to leave your heirs (and/or your favorite charity/s) the bulk of your ‘fortune’

PS What does the image of a man running on the beach have to do with a ‘safe retirement’? I have no idea … I just googled images with the keywords ‘safe’ and ‘retirement’ and pictures of beaches and horses (lots of horses!) came up … go figure …

Your employer may be stealing from you!

Intrigue over at 7m7y.com! Who’s the Millionaire … In Training leaving? And why? Click here to find out …

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“Oh, little 401k, how I hate thee … let me count the ways” (2008, Anon.)

I don’t know who first uttered these words but, they strike a chord with me; here are some (admittedly, slightly cynical) reasons NOT to like the humble 401k:

1. Little or no choice of investments

2. Have to wait to traditional retirement age to receive the benefits

3. Stuck with low-returning investment choices

4. Little or no opportunity to ‘gear’ (I guess the employer match and tax benefits counts as a kind of gearing)

5. Fees

6. Your employer may be ‘stealing’ from you

Stealing?!

Yeah, in a way … but, first let’s take another quick look at fees [AJC: Inspired by a comment left on a post by Dustbusterz ... thanks 'Dusty'!]; in 1998 (!) the Department of Labor received and published an independent Study of 401(k) Plan Fees and Expenses.

It found the following average fees being charged by the larger 401k funds:

Total Annual Plan Fees

Lowest       0.57%
Mean         1.32%
Median      1.28%
Highest     2.14%

(Source: Butler, Pension Dynamics Corporation, in Wang, Money, April 1997)

Now, this goes back to 1997, but I just covered some very recent work by Scott Burns, noted financial columnist, and published in his new book, Spend ’til the End, which points to the fees continuing to trend up, citing average (mean? median?) fees of 1.88% now.

Remember that, according to Scott, even a “1% increase in a fund’s annual expenses can reduce an investor’s ending account balance in that fund by 18% after twenty years”!

I calculate that a 1.88% fee reduces your returns after 20 years by a whopping 38% …

But, do you know how your employer actually chooses your funds / 401k provider? On the basis of better returns to you? Given the possible 38% ‘hit’, you would assume at least on the basis of lowest fees for you?

Right?!

Nope … not a chance. In fact, the study quoted an earlier report that found that “78% of plan sponsors [employers] did not know their plan costs” (Benjamin) …

… Great! You are putting your financial future into the hands of your employer, 3/4′s of whom don’t even know what the plans that they are choosing will cost you!

So how do they choose the plan that’s right for you [AJC: ironic snicker]?

The study found, one of two ways:

1. In my opinion, an unethical way: The Study of 401(k) Fees and Expenses quoted a prior report that found employers most often choose “the institutions that furnish the firm other financial services – banking, insurance, defined benefit plan management – to provide their 401(k) plan services and may not make an independent search for the lowest cost provider.”

Your employer feathers the bed of their own business relationships with your retirement money. Nice!

2. In my opinion, a criminal way: That would have been enough for me, if I hadn’t accidentally come across what is regarded as the Retirement Industry’s ‘Big Secret’ … it’s a doozy: it’s where the 401k provider shares some of the fees that you pay them with your boss!

Think about it; your employer provides you with a match to encourage you to remain employed then gets back some of that in fees, rebates, ‘free’ services, or just good old ‘relationship building’ at your expense, literally!

How do the funds and your bosses get away with this? Simple, nobody’s looking: “Revenue sharing is a poorly disclosed and relatively unregulated practice, which falls into the gap between Department of Labor and SEC oversight.”

OK, so does this mean that you shouldn’t participate in your employer’s 401K?

Not at all … it just means that you should do the following:

1. Decide if the 401k is going to do the job for you … will it get you to your Number? At a maximum ‘investment’ of $15,500 per year and a compound annual growth rate of 8% – 12% less fees, this is highly unlikely … you run the numbers then make your choice!

2. If not, is it still wise to continue your 401k (consider it a backup plan) as well as more aggressively investing elsewhere?

3. If you can’t do both, you have no choice but to decide which investing strategy is going to have to give way to the other?

4. If you do decide to continue with the 401k, choose any ultra-low-cost Index Fund option that may be on offer over any other selection; if not available, choose a ‘no load’ fund (be careful … some ‘no loads’ are actually just ‘lower load’). And, do your own homework on fees, because you just know your employer ain’t doing it!

5. Lobby your employer to pass back any revenue-sharing back to the employees

6. Insist that your employer choose funds that work best for you over the funds that work best for them.

What you do with this information is entirely up to you; I don’t need a damn 401k … never have and never will

Making Money 301? Hold on to your horses ….

Part 3 of a 3 part series on weathering the current financial storm …

By now you know that when we have made our Number, our #1 objective is to hold on to our money!

We do that by a combination of wise spending and savings habits (learned way back in Making Money 101, and practiced almost to the point of stupidity in Making Money 201) and very sound investing strategies.

Firstly, though, what do you do if you have just had the wind kicked out of your 401k’s sails by the sudden crash?

Well, it really shouldn’t be an issue, because the chances are that you planned for an annual stock market return of something like 11% – 12% over 20 years and you overachieved dramatically for most of it … but, rather than increasing your spending based upon your unexpected ‘good fortune’ you realized that all good things must come to an end and you gritted your teeth expecting a reversal to bring you back to earth.

In fact, if you were really smart, you set yourself 10 or 20 year ‘targets’ and when you achieved those, you started preparing for Making Money 301 early and sold down your excess stocks and/or real-estate (i.e. the equity in excess of your ‘target’) and moved it into cash, bonds, or far more boring commercial real-estate investments (using minimal, if any, borrowings).

Now you are retired (well, you at least aren’t counting on any outside income), but you have been battered and bruised a little by the current ‘meltdown’ so your buffer isn’t as large as it was a few months ago, but you are still OK.

[AJC: I'm speaking from personal experience, now]

Remember, your Rule of 20 strategy was designed to deliver 5% of your ‘nest egg’ to live off each year, leaving another 5% to be reinvested to keep pace with an expected 5% average inflation … in other words, produce an indefinite stream of annual income that grows with inflation.

The problem is 5% + 5% = 10% AFTER TAX, so we NEED a 12% to 15% compounded annual growth rate to make all of this work …

… and, the current crash has probably temporarily wiped out most of any buffer that we had managed to retire with i.e. any money that you managed to salt away in excess of expectations … who said that EXACTLY Your Number was going to fall into your lap EXACTLY on Your date?!

What to do, given that there are signs of a prolonged flattening of the market?

Here are a some advanced strategies, sensible in ANY market for Making Money 301, but particularly now:

1. Do NOT keep your money in CASH (other than a 2 year Emergency Fund) – if you have no buffer, then every year you earn ONLY 5% on your CD’s is a year that you are really LOSING 5% of the remaining value of your ‘nest egg’ to inflation!

Equally, do not keep it in a cash-equivalent (e.g. bonds – with the exception noted below) OR in stocks or Index Funds: you need a min. 5% return – indexed for inflation) UNLESS there are stocks that you understand/love that pay a 5% dividend and you are 100% certain that dividends won’t be cut in the coming recession.

2. Purchase commercial property for 100% cash or very low LVR (Loan-to-Valuation ratios), such that the net rents each year provide EXACTLY the annual income $$$ amount that you are looking for + 25% ‘buffer’ (for vacancies, repairs/maintenance/etc.). If you are worried by commercial, residential (or a mixture) is OK.

You can spend the entire rent (except for the buffer) as it will:

a. Keep up with inflation, because you will have a CPI ‘ratchet clause’ in your lease, if you rent well, and

b. Your capital (represented by the property itself) will also at least increase with inflation, if you buy well.

3. Buy a select group of ‘blue chip’ stocks that you love/understand (etc., etc.) on low historic P/E’s and write Covered Calls against them; this works well in a flat-to-slightly-growing market, so the current volatility may need to settle into a more extended period of gloom-with-some-slight-hope before you can execute properly … but, now’s a great time to start (very!) small and experiment!

4. Be boring: buy TIPS (Inflation protected Treasury Bonds), but only if you applied the Rule of 40 instead of the Rule of 20 … these currently only produce about 2.5% TAXABLE annual income (except if your Number is so small that ROTH IRA’s – or similar – will do the job for you).

Only buy the TIPS using 95% of your ‘nest egg’; retain 5% of your cash (over-and-above that emergency fund – although, holding TIPS means that you can probably cut this back, as well) … use it to start buying Calls against the market (pick an ETF that tracks the S&P 500) or, against 4 or 5 individual stocks if you are more daring.

While you’re waiting for the market to stabilize a little, now’s a good time to start slow and practice: after each major pull back, buy a Call and see if you can make a gain on the upswing (set a profit target and sell when your reach it … wait for the next ‘pull back’ and try again).

5. Buy a Fixed Annuity – costs suck, but if you can’t do 2. or 3., what’s really left for you besides TIPS or this?

And, if it (in fact, any of these strategies) produces your required Annual Income Number (the annuity MUST be indexed for inflation) who cares? But, remember to spread your risks over a few insurers (remember AIG?) … you don’t want them to go down holding your cash (keep in mind that even if the insurer crashes, your underlying investments should still be safe and be handed back to you … at least, that’s how the story goes)!

So, for any rich readers out there sweating my posts (you know, like the doctors who watch ER just to point out all the faults: “Oh, what a bunch of BS … he’d never spline the clavicle with a Humphreys 458!”):

What’s worked for you in past ‘bear markets’? What do you think will work for you in this one?

Retirement Planning Made Easy!

Meg, a reader, asks:

My goal has long been to reach $1MM (net worth, not assets) by age 30 – which is under 6 years away for me. I’ve been working actively towards the goal for over a year now, so if I reach it it will have been $1MM in 7yrs. Not nearly as impressive as 7MM in 7 yrs, but that’s if I do it the most conservative way possible with minimal risk and leverage. If all goes according to that plan (which primarily involves utilizing real estate leverage) I will reach $2MM by 35 and then more than double it again by 40…of course that’s almost 2 decades away. Maybe I should look into ramping up my plan with some risk!

[AJC: My response ...]

Meg,

Sounds great!

Now, I suggest that you work backwards:

How much income do you need (forget inflation for now, just use today’s dollars) and by when (figure costs of family, college, travel, etc.) … no more work for you OR hubby from then on!

OK, then double that amount for every 20 years until The Date (that accounts for 4% inflation) … and, multiply by 20 (if you want to be really conservtive, multiply by anything up to 40) to get The Number – that’s your Net Worth target (assuming that you also obey the 20% Rule).

Now, do you need to ramp up your plan with some risk, or not?!

Retirement Planning Made Easy!

Good Luck!

AJC.

Who wants to retire in their 20's, anyway?

Join AJC’s Live Video Chat on Thursday @ 8pm CST … 7 Millionaires … In Training LIVE Results Show: Final 30 announced live tomorrow (!)

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Yesterday we talked about starting young, not just as it applies to saving, but as it applies to accelerating your retirement plan.

Maybe you couldn’t find your WHY?

After all, who wants to think about retirement when they are still in their 20′s or even 30′s? Most are still thinking about their job!

Yet, as yesterday’s post showed, there are some good reasons for starting early. And, who wouldn’t want to retire early if their goals matched these from a recent survey of GenXfinance‘s readers:

Being a ‘Gen X’ PF site, we can probably assume that most of the respondents were younger than, say, me. But, it’s even more interesting to notice how each of the first three categories (where the majority of the votes fell) require MONEY and/or TIME:

1. Extensive Travel

Think about it, you can escape money to a greater of lesser degree if you are willing to travel frugally, work at least during some of your stopovers (haven’t you noticed how all the ‘servers’ in restaurants in vacations areas are young foreigners?) …

… but, you can’t escape the time element: this means that you have to be ‘retired’ from your day job.

2. Not going to work; just taking things one day at a time

Obviously, this means that you are retired from your day job … but, two things happen when this occurs:

i) Your income goes DOWN

ii) Your spending goes UP

For those who subscribe to the “75% of current income in retirement” theory, I ask this: have you ever tried spending time doing anything BESIDES WORKING that doesn’t COST money?

Think about it … it stopped me from cashing out when I was offered $4 mill. a few years before I eventually did cash out (for a helluva lot more!).

3. Doing volunteer or charity work

All [charity] work and no play makes Jack a dull boy … this is really 2. plus you are spending some of your time (perhaps a lot) giving back. This is a good thing … as well as the great work you are doing, you are spending less time … well … spending!

4. Other

If you scroll down the comments attached to GenXfinance’s post, you will see that most of the ‘other’-folk either mean not retiring at all (like the ‘pursuing a second career’ option) or involve a similar outflow of money and/or a similar savings-account-draining, non-income-earning amount of time.

But, they are all things that you will probably want to start whilst still young enough to enjoy them …

… which means starting to build a pretty damn large nest-egg pretty damn soon!

Let me know what (and how much by when) ’retirement’ means to you?