LivingCheaply.net » Retirement

SEC Proposes New Rules for Target Date Funds

cheapo — Tue, 20 Jul 2010 10:00:43 +0000

This post is from GRS staff writer April Dykman . During the 2008 financial crisis, target date, or life-cycle, funds were hit hard. People who were just a couple years away from retiring held 2010 target date funds that lost 24% of their fund’s assets on average , with a range of 9% loss to a staggering 41%. Same date, different allocation According to the Securities and Exchange Commission (SEC), many investors believed that their asset mix would become more conservative as they neared the target date. But what many didn’t know was that the amount of risk could vary widely, even among funds with the same target date. From the Washington Post : The SEC said that life-cycle funds with the same target date had equity exposures that ranged from 25 percent in stocks to 65 percent. It could be years after the target date is reached before a particular fund’s asset mix switched to a more conservative approach. Proposed rules to educate investors To increase investor understanding of how these funds work, last month the SEC proposed new rules for target date funds in a 100-page report and is seeking comments from the public about the proposal. The highlights include the following: Marketing materials would have to disclose the asset allocation as a tag line with the fund’s name the first time that name is used. The proposed rule would allow an investment company to list a range of allocation for an asset class, such as “30-35%”. Target date firms will have to provide investors with a graphic depiction of asset allocation for the life of the fund (from start date to target date). Firms will have to provide investors with a statement explaining that the asset allocation changes over time, stating the year the asset allocation becomes final, and providing the final asset mix. Marketing materials will have to advise the investor to consider his or her risk tolerance and financial situation; that it’s possible to lose money; and whether the planned percentage allocations can be changed without a shareholder vote. Finally, target date funds have been touted as a “set it and forget it” solution to retirement, but being too hands-off with your money has consequences. To address this, the SEC proposed changes to its antifraud guidance to address the age emphasis and “set it and forget it” representations of target date funds. The SEC noted that marketing materials that lead investors to believe an investment is appropriate for them based solely on age (or target age of retirement) or that the plan is easy and doesn’t require monitoring, are misleading. Are rules tough enough? While most experts agree that more disclosure is good news for investors, others don’t believe the SEC rules are tough enough . Criticisms include the following: The phrase “target date” is misleading and should not be allowed to be used in a fund’s name. The perception is that a 2030 target date fund will provide retirement income for an investor in 2030, and disclaimers are unlikely to change that perception. Some experts don’t mind the name, but feel like complicated graphs and confusing fact sheets won’t be easily understood by the average investor. Instead the investor should be told what sort of income is probable given their investments, rate of savings, asset mix, and years until retirement. The SEC should do more to explain that target date funds are not guaranteed. Critics point to the fact that the Employee Benefits Security Administration has deemed target date funds as a Qualified Default Investment Alternative (QDIA). In plain English, this means that if an employee neglects to direct their 401K investments, the employer can select a target date fund for them without being held liable. So while the SEC can say the funds aren’t guaranteed, the fact that they are a QDIA will continue to send the wrong signal to many investors. Target date funds are still a good option for many people, but it’s wise to invest with your eyes open. To help investors better understand target date funds and what to know before investing, the SEC and the Department of Labor issued an Investor Bulletin that explains how the funds work, how to evaluate them, and what to know before investing. Personally, I’m a fan of target date funds because despite writing about personal finance almost daily, retirement talk makes my eyes glaze over. Nevertheless, I am one of those investors who picked a target date fund without fully understanding much of what the SEC wants to clarify, and now I appreciate how important it is to do some homework when choosing a target date fund .

Originally posted here:
SEC Proposes New Rules for Target Date Funds

Review: The Smartest Retirement Book You’ll Ever Read

LivingCheaply — Sun, 11 Jul 2010 19:00:32 +0000

Every Sunday, The Simple Dollar reviews a personal finance book or other book of interest. Daniel Solin’s series of The Smartest X Book You’ll Ever Read have turned me off for their title alone, and thus, to this point, I’ve not read them. The title set off a big “questionable investment planning” warning light inside my mind and, with a lot of other options to choose from, I just kept passing on books in this series. As is often the case, though, a long-time reader emailed me and strongly encouraged me to give this specific book a shot, mostly because he felt it addressed retirement savings from new angles that he hadn’t considered before. I do enjoy reading personal finance books, particularly ones that add new ideas to familiar topics, so I headed out to my local library and picked this one up. I do have to say that it did include some ideas and angles on retirement savings that were certainly intriguing and provided food for thought. Let’s dig in. One | Rethink Retirement Investing Right off the bat, Solin makes the vital point that if you don’t protect your portfolio against inflation, you’re going to run out of money much sooner than you would like. Inflation is a force that constantly pushes against your retirement savings, making every dollar you save today worth less when you retire. This is a particular problem for conservative investors who would like to keep their money low risk and “safe” – they won’t lose money, but they’ll often earn at a rate lower than inflation, which means the real value of their money is actually decreasing over time. The best solution, then, is to balance the two – keep a healthy portion of your money in stable things (like cash or CDs or savings accounts or treasury notes), but put some of it into other things with more growth potential that can keep your overall portfolio ahead of inflation. Two | Stocks Made Simple Individual investors shouldn’t invest in individual stocks (unless it’s just for fun) because the risk is just too great. You don’t want to bet your retirement on one company lest it turn out to be the next Enron. Instead, you want to mix it up: invest in broad-based index funds, some of them with lower risk and some of them with higher risk. So, for example, your overall portfolio might be 1/3 in cash or treasury notes, 1/3 in a total stock index, and 1/3 in an international total stock index. The key is to buy index funds for your investments – they spread out your risk while also keeping the fees very low. (I do this myself – I have my money with Vanguard.) Obviously, as you move closer to retirement, you’re going to want less of your money at risk, so over time you’ll migrate more and more to cash and treasury notes and less and less in stocks. One easy way to do that is to just buy “target retirement funds” which automatically handle that transition for you (again, making sure that these “target retirement funds” are made up of low cost index funds). Three | Bonds Made Simple Bonds are a great way to get solid returns in your portfolio with relatively low risk. Solin recommends that most investors should have at least some of their retirement money in a broadly diversified, low-cost bond index fund. It’s important to remember, though, that bonds aren’t riskless. They have less risk than stocks, but they’re not entirely free of risk. Solin also suggests that investors worried about inflation should not buy TIPS (Treasury Inflation-Protected Securities) because they’re very volatile and they earn very poorly in times of low inflation (like right now, for example). Four | Cash Made Simple You should never keep cash in a bank that doesn’t have FDIC insurance, and you should make sure that your cash savings never exceeds the FDIC insurance cap (currently $250,000). Solin encourages searching around for banks if you’re just looking for a place to sock away your cash savings (I suggest using BankRate ). Five | Annuities Made Simple Solin is a big fan of immediate annuities – annuities in which you give a cash sum to an investment house and receive payments for the rest of your life from them. He argues that they greatly reduce the risk of outliving your money, even if the returns aren’t stellar. Another option is a charitable annuity, where you give a lump sum to a charity and they issue you payments for the rest of your life – this ensures that your annuity lump sum winds up in the hands of a charity you care about instead of a business. If you do get an annuity, though, Solin recommends a fixed rate annuity, not a variable rate one – they carry too much risk. Your annuity should have a fixed rate, period. Six | Mining Your Money Do not trust historical returns when you’re trying to figure out how much you can safely withdraw from your retirement each year. Instead, you should simply focus on withdrawing as little as you can get away with each year. Solin suggests aiming to withdraw between 2% and 4% of the total each year – I think that’s a great target (he offers some more math-intensive guidelines as well). He also offers a few exceptions to that “2-4%” rule that involve market timing, a subject that I don’t agree with him on (I don’t think market timing is usually a good move). Seven | Simple Steps to Stretch Your Money When you start taking withdrawals, withdraw from your taxed accounts first (like any ordinary savings or investment accounts), then deferred retirement savings accounts (like a 401(k)), then Roth IRAs last. Why? The longer money stays in a tax-deferred account, the longer it has to grow in value without Uncle Sam feeding off of it. If you have a 401(k), Solin recommends rolling it over into an IRA if you can because this gives you more control and the ability to utilize lower-cost investments. He also thinks converting your IRA to a Roth IRA (and everyone with an IRA can do this in 2010) is a good move for almost everyone, but particularly high income earners. Eight | Social Security and Pensions: Critical Choices If there is any possible way to delay taking Social Security, do it. If you can wait until you’re older, you’ll get higher payments for life. It can also adversely affect the quality of life of a spouse that survives you. Also, don’t bank everything on a pension because, as we’ve seen recently, companies sometimes aren’t 100% reliable in paying out the pensions they’ve promised. If you do have a pension, avoid taking the lump sum option (if you have it) and take monthly payments instead. Nine | Is Sixty-Five the New Fifty? People are living longer lives and staying healthy much longer. What this means, to put it simply, is that if you retire at the traditional retirement age, you’re going to have to cover many more years than the generations before you had to cover for themselves. The solution, of course, is a simple one: work longer. Turn your early “retirement” years into a continuation of your career or the crest of a second one. Don’t rely on age discrimination laws to help you, either – everyone is responsible for keeping their skills up and building their own paths. Ten | Financial Lifelines for Desperate Times What if you’re running out of money? A reverse mortgage (meaning you give your home’s deed to someone else and in exchange you receive regular payments) is an option, but it should be your absolute last one. Why? They’re expensive – they’re loaded down with tons of fees and you’ll get nothing close to what your home is actually worth out of it. Instead, seek other options. The AARP is a spectacular resource for the elderly, as are local churches and civic organizations. Eleven | Care Costs One of the major costs a person often has in retirement is medical care. Before you even consider retirement, you’ve got to know what your medical care options are when you retire. Is there any continuing coverage from your current job? Can you make ends meet with Medicare? Do you need long term care insurance? Solin spends quite a few pages on long term care insurance and basically argues that the lower your net worth is at retirement, the better an idea long term care insurance is (because if you have more money, you can pay for more care out of pocket). Twelve | The State of Your Estate Everyone needs a will, but a will has severe limitations that can hurt you if you’ve spent a lifetime building wealth. A better option for people with a high net worth that wish to pass on their money is to set up a living trust, assign their assets to that trust, and receive payments from that trust until they pass away, at which point their instructions for further management of the trust (i.e., who gets the money) is followed. Also, older couples are very well served by having prenupital agreements that specify that some assets get left to children when one member of the marriage dies. Thirteen | Wolves in Sheep’s Clothing If you need financial advice, be careful – there are a lot of sharks in the water. Avoid people who are offering you free things (like lunch) to listen to their pitch. Instead, seek out assistance on your own terms. Look for financial advisors who are fee-based, can explain things clearly, and aren’t seeking to constantly beat the market (such people often wind up way over their heads and you’re left holding the bag). The book closes with a large handful of appendices and additional documentation for many of the points made in the book. Is The Smartest Retirement Book You’ll Ever Read Worth Reading? I think The Smartest Retirement Book You’ll Ever Read is a very strong retirement book for high income earners – the people who aren’t having to make hard decisions about whether to save for retirement or accomplish other life goals. It pretty much assumes you’re going to be socking away plenty and that your questions revolve around where to put it. If you’re in that group, The Smartest Retirement Book You’ll Ever Read is a very worthwhile read. Solin keeps an eye on the real world (inflation, business failure, etc.) and explains the logic behind every move he recommends in a very clear and straightforward fashion. If you’re really hitting your income stride and are looking for some sound advice on what investments to put your retirement money in, The Smartest Retirement Book You’ll Ever Read is a pretty strong choice for a good read, in my opinion.

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Review: The Smartest Retirement Book You’ll Ever Read

Choosing a Target-Date Fund

jos — Wed, 07 Jul 2010 19:00:02 +0000

This is a guest post from Edwin Choi, the founder of Mariposa Capital Management . Edwin is a fee-only investment advisor in Los Angeles and a long-time reader of GRS. Prior to starting Mariposa, Edwin Choi spent several years as a portfolio manager with Merrill Lynch in New York. So, you find the lazy way to invest very appealing: You like the simplicity and the long-term results. But you don’t want to bother with building your own lazy portfolio of index funds and adjusting it as you get older (same as creating your own target-date fund ). At this point in your life, you just want a set-it-and-forget-it solution, at least until you feel more comfortable building your own investment portfolio. Target-date funds seem perfect for the job, but which one is right for you? Choosing the Fund Family The first step is to choose the fund family (Fidelity, Vanguard, etc.). This decision cannot be overlooked since each company manages its funds differently; a 2040 target-date fund from T. Rowe Price will be different from a 2040 target-date fund at Fidelity. Each company has its own philosophy and methodology. Let’s compare the three biggest players in this market: Fidelity Freedom Funds, T Rowe Price Retirement Funds, and Vanguard Target Retirement Funds. The first criteria you can use to compare the fund families is cost, specifically the expense ratio (the total annual cost for things like advertising and managing the fund). As an example, let’s look at the 2040 funds: Fund Family Expense Ratio Fidelity 0.79% T Rowe Price 0.79% Vanguard 0.20% Amazingly, Vanguard’s expenses are roughly a quarter of the other two. This is largely due to the use of actively-managed mutual funds by Fidelity and T Rowe Price; Vanguard only uses low-cost index funds in their target-date funds. If you think 0.59% a year is a pretty small difference, remember that the rough rule-of-thumb for withdrawing money in retirement is only 4% a year. That “small” difference in expense ratios is almost 15% of your potential retirement income! Another important criteria to consider is the asset allocation used by the target-date fund — how much is invested in stocks, and how much is invested in bonds and other instruments. In particular, you want to look at how that allocation is expected to change as you get older. Investing geeks like me call that the “glide path”. Let’s compare the stock portion of the glide paths used by the three fund families: As you can see, although all three glide paths have roughly the same shape, the differences are material. T Rowe Price is consistently the most aggressive; Fidelity is generally the most conservative except for the strange kink around 2005-2010. Ten to fifteen years into retirement, your allocation to stocks can vary from 20 to 40% based on the fund family you choose. Choosing Your Target Date Once you select the fund family, you need to decide on the specific fund to buy. Target-date funds are labeled by retirement year, generally assumed to be when you turn 65. So the 2040 fund is designed for the “typical” person who’s currently 35 and is expected to retire in 2040. Obviously, no one is forcing you to buy the fund that corresponds to the year you turn 65. There are at least two very good reasons to adjust your target date: If you plan on retiring much earlier or later than 65, you should consider adjusting your target date. Let’s say you’re 35 and want to retire at 55. Should you buy the target-date fund for 2030, since that’s when you’d retire? Not necessarily. Although the 2030 fund fits your retirement plans, it also assumes people retire around age 65, so your life expectancy is probably much longer than the target audience for the fund. A good compromise might be the 2035 fund, which respects both your early retirement plans and your longer life expectancy relative to others you retire with. Even if you expect to retire at 65, the amount of risk you want to take is probably not “typical”. An easy way to reduce risk is by selecting a fund with a target date that is five to ten years before when you turn 65. (So, if you plan to retire near 2040, you might choose a 2030 target-date fund.) This lowers the level of risk by holding less in stocks while still considering your investment horizon. And if you want more risk, you can select a target date that is five to ten years past when you turn 65. (If you plan to retire around 2030, you could increase risk by choosing a 2040 target-date fund.) Even though they’ve received some bad press lately due to their poor performance during the recent stock market crash, target-date funds are still useful investments for many people. They’re certainly better than other strategies commonly used by beginning investors: equal-weighting all funds within a 401(k) plan, picking stocks, or just leaving everything in a money market fund. If you already use target-date funds, which funds do you own and how did you choose?

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Choosing a Target-Date Fund

Choosing a Target-Date Fund

LivingCheaply — Wed, 07 Jul 2010 19:00:02 +0000

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Choosing a Target-Date Fund

Ask the Readers: Should I Invest or Prepay My Mortgage?

cheapo — Fri, 02 Jul 2010 10:00:49 +0000

Kelley wrote recently with the sort of dilemma I get asked about all of the time : Is it better to invest or to prepay a mortgage? We’ve covered this topic in the distant past, but it’s time to review the debate for current readers. First, let’s look at Kelley’s e-mail: My husband and I are on the right track. At age 25, our only debt lies in our home mortgage. We have the six-month emergency fund in place, I currently meet the 3% 401(k) match offered by my employer, and I started a Roth IRA for myself and my husband last year. I started each Roth IRA with $4,000. My financial advisor recommended for us to max out each of our Roth IRAs each year. My husband disagrees. He thinks paying off the house is a bigger priority. Starting this year, we’ve made an extra payment on our house each month. If we continue doing this, we can have our house paid off in nine years rather than 30 years. However, we can’t do both. Currently we’ve decided to throw $1,000 into each Roth each year until the house is paid off. Is this the wise decision? Or is it better to put more toward the Roth IRA and less toward the house? I understand either option is good because I’m saving money. I’m just curious of which route would be wiser. Kelley’s right: Both of these options are good. This is like choosing between an apple and an orange. Both taste good, and they’re good for you &madsh; but is one better for you in the long run? What the experts say Three years ago, when we last covered this topic (holy cats! — where has the time gone?), I collected the following roundup of advice from personal-finance books: Ric Edleman ( Ordinary People, Extraordinary Wealth ): Never own your home outright. Instead, get a big 30-year mortgage and never pay it off — regardless of your age and income . “Every time you send an extra $100 to your mortgage company, you deny yourself the opportunity to invest that $100 somewhere else.” Suze Orman ( The Laws of Money ): Invest in the known before the unknown. Paying off your mortgage offers a guaranteed return on investment. “You cannot live in a tax return. You cannot live in a stock certificate. You live in your home.” Elizabeth Warren ( All Your Worth ): Save 20% of your income. Use 10% for retirement savings, 5% to accelerate your mortgage, and 5% to save for future dreams. “Paying off your home also does something many financial planners neglect to mention: It gives you freedom. Once that mortgage is gone, just imagine all the freedom in your wallet.” Dave Ramsey ( The Total Money Makeover ): Prepay your mortgage if you can, but only after you’ve saved an emergency fund, and only if you’re putting at least 15% of your income toward retirement. Don’t use a program designed by a broker; use your own self-discipline. Dominguez and Robin ( Your Money or Your Life ): “Pay off your mortgage as quickly as possible.” This book, too, was written when interest rates were higher. Also, the authors emphasize frugality over investing. Financial authors don’t agree on this subject. Maybe the personal finance gurus writing for the web can clear things up? Liz Pulliam Weston at MSN Money : Don’t rush to pay off the mortgage. “You’ve got better things to do with your money, like saving for retirement, building an emergency cushion or even living it up a little.” Walter Updegrave at CNN Money : If you’ve funded your retirement, and if it will make you happy, then pay down the mortgage. Otherwise, it makes more sense to invest. Laura Rowley at Yahoo! Finance : Using very conservative figures, investing instead of prepaying the mortgage yields an extra $400 per year. If you feel compelled to pay down your mortgage, do it. But realize you’re paying a price to do so. (She offers more details at her blog , as well as tips on how to estimate the investment return you need to earn to make it worthwhile.) Bankrate : Pay down your mortgage if your investments would be conservative. Invest if you’re planning to do so for the long term. USA Today : It depends on your income, your monthly expenses, your risk tolerance, and your desire to own your home free and clear. Kiplinger’s : Invest unless you’re near retirement The Dollar Stretcher : Mathematically, it makes more sense to invest, but it all depends on your risk tolerance. My fellow pfbloggers at Bargaineering and Million Dollar Journey recommend that a person do a little of both: pay down the mortgage some and invest some. Free Money Finance says: “If you have the discipline to save/invest the money you would be using to pay off the mortgage, it’s likely that saving/investing is the better option. But if you’re more the “average” person out there managing your money, I still believe it’s a better option to pre-pay your mortgage.” The Rowley article offers some interesting background to this debate: Why do so many people choose to put extra money into a mortgage when other options would likely increase their wealth? “This is really remnant of Depression mentality that has persisted from generation to generation,” says [one expert]. At the time, most mortgages had one- to five-year terms, with a lump sum payment due at the end. “Any shock to income meant you couldn’t afford your payment — mortgages were much more susceptible to economic uncertainty,” [the expert says], and roughly one-quarter of Americans were unemployed during the Great Depression. “It’s fine to pay down your mortgage if it gives you peace of mind, but you should recognize what that peace of mind costs.” If you’re facing a similar decision, you may find this calculator useful: prepaying your mortgage vs. investing . The bottom line My conclusion in 2007 (and the one I still hold today) is that unless your mortgage rate is very high, it makes more sense mathematically to invest your money . But most gurus agree that psychologically , you should do what works for you. If paying off your mortgage would take a weight off your shoulders, then pay off your mortgage. Sure, you might be losing a bit in the long-term, but you’re still making a smart choice. As I said earlier, it’s like choosing between an apple and an orange. One may be better for you, but they’re both good. Ultimately, I kind of like the choice that Kelley and her husband have made. They’re prepaying their mortgage and putting some toward retirement. But enough of what I think. Kelley really wants to know what you think. Which option is better? Should she and her husband be pumping as much as possible into their Roth IRAs? Or should they be paying down their mortgage as quickly as they can? Have you been faced with a similar dilemma in the past? What did you choose to do? And would you make the same choice again?

In Praise of Paying Yourself First

LivingCheaply — Mon, 14 Jun 2010 18:07:03 +0000

Can you bear with me for one more labored metaphor? As I’ve mentioned a few times already, I’m in the midst of a successful fitness program. I’ve lost 20 pounds since the beginning of the year, and, more importantly, I’m exercising every day. This morning, for example, I pedaled 8-1/2 miles to my Crossfit gym ; spent an hour practicing skills, doing body rows (pull-ups for people who can’t do pull-ups), and lifting weights (front squats); and then I biked 10-1/2 miles home. According to my handy body bug , I burned 1500 calories by 9 a.m., which means that I can spend the rest of the day blogging, working in the yard, and learning French, secure in the knowledge that I’ve already done 2-1/2 hours of exercise. This, my friends, is essentially the routine I’ve established lately. I get my exercise in first thing so that I don’t have it looming over me for the rest of the day. I don’t want to find myself eating dinner while wondering when I’m going to find time for a one-hour run. When that happens, I feel guilty and often don’t follow through. (And yes, I realize I’m lucky to have a flexible schedule that lets me fit in an hour or two of exercise every morning.) Pay yourself first One of the reasons my financial life has been humming along so nicely lately — except when I forget to pay my bills — is that I’ve been applying similar principles to my budget over the past few years. It used to be that when I got paid, I’d pay my bills, then use any leftover money to buy stuff I wanted today instead of setting anything aside for the future. In fact, I never saved anything. Despite earning around the median income for men in the U.S., I never seemed to have money left over at the end of the month. (I didn’t even have a savings account until after I started this blog!) But as I began to dig myself out of debt, I read a lot about the importance of paying yourself first . For a while, I didn’t get it. I didn’t understand what people meant when they said this; after I started making debt reduction a priority, it started to make sense. If, when you get paid, you set money aside for your financial goals before paying bills and buying toys, it’s far easier to achieve your dreams. So, for example, when I was working my debt snowball , I made sure that the first thing I did when I got paid every month was to pay down my debt. Next, I paid my bills. And if I had money left over (and I usually had a little), I used that to buy comic books or to eat at a restaurant. Once I’d repaid my debt, I continued to pay myself first. But instead of using the money to pay off my past, I used it to pay off my future. I began to save for retirement. I started by setting up a Roth IRA through Sharebuilder , which automatically pulled $333 from my checking account. When I realized I could also set up a solo 401(k) through my business, I did so, and I started funding that as much as I could and as soon as I could. Note: I no longer use Sharebuilder for my Roth IRA. All of my investment accounts are with Fidelity. There are many other great choices out there, including Vanguard. If you’re looking to open an account, take the time to find the one that works best for you and your needs. Now I’ve reached a point where I not only try to fund my financial goals early each month, but I also try to fund them early each year . Once I decide how much I want to save for retirement each year, I try to invest that money as soon as possible. (By May or June is ideal.) And in a move that’s sure to drive certain readers crazy, I actually try to pay my taxes as soon as I can, too. As a small-business owner, I’m required to make quarterly payments on my estimated taxes. What I do instead is save like a madman during the first few months of the year so that I can pay all of my estimated taxes by the end of April. King of the world Why do I do this? Why am I so obsessed with paying myself first? Because I’ve found that it feels fantastic to know I’ve met my financial goals before I’ve even had a chance to spend the money on other things. Just as I can sit here at my desk, basking in the warm glow that comes from knowing I’ve already finished my exercise for the day, so too paying my taxes early (and funding my retirement as soon as I can) lets me spend the rest of the year without a black cloud hanging over my head. This year, for example, I can save for our trip to France and Italy without wondering if I still need to set money aside for taxes. Simply put: When I pay myself first, I feel like I’m king of the world. Note: It just occurred to me that if I were really smart, I could still accumulate all my money for taxes, but then just set the cash aside in a high-yield savings account instead of sending it all in April. Sometimes I’m not really smart, though — sometimes I’m only half-way smart. Okay, that’s enough with the money metaphors. I’ve used them a lot lately, so I’ll give them a bit of a rest. Inspired by the comments on this morning’s post , Wednesday discussion will be an “ask the readers” about the processes and systems you use to keep your financial life flowing smoothly. (Tomorrow’s article is from April.) — Related Articles at Get Rich Slowly: Daily Links: Homemade Cars and Urban Farming Free Debt Snowball Spreadsheet Buying a Home, part three: Dealing with Debt Ask the Readers: Pay Down Debt or Save for Retirement? Ask the Readers: How to Live Debt-Free?

What Does an Extended Lifespan Really Mean in Terms of Retirement Savings?

cheapo — Sat, 12 Jun 2010 19:00:38 +0000

Here’s a number for you. Half of all babies born in the United States this year will live to age 104 or older . In other words, when a person from that generation hits the typical “retirement age” of 65, they’ll still have 40 years of life left. Obviously, this represents a major change from where we’re at now. At age 65, people will have 40% of their life yet to lead. In other words, 65 will become the new 40. Social Security cannot support everyone having forty years of retirement. It will have to drastically change or go bankrupt. There is no other option. The only way to prepare for this is to assume that Social Security simply won’t be there when you reach retirement age. Few people will want to “retire” at age sixty five. If 65 is the new 40, people aren’t going to want to retire then. They’re going to want to keep having active, productive lives for many, many years to come after 65. Thus, the age range for retirement savings will become much longer. People will start targeting their retirement savings to age 80 or 85. Money put into such savings at age 25 will have 55 to 60 years to grow. When I look at my children, I recognize that these are the facts that their lives are going to hold. How exactly will they plan for the future? What will their lifelong financial trajectory look like? Here are a few elements I see coming down the pike – and they’re certainly going be a part of the advice I give to my children. First of all, their first career probably won’t be their only career. The idea of the “second career” is slowly becoming more and more mainstream as people reach “retirement” and realize they don’t want to retire. As people’s life spans continue to extend, the idea of a second career will become pretty normal. I expect that many people will work hard at a lucrative “first career” and then move on to a pesonal passion for a “second career” once their major life expenses (a home, children) are taken care of. What does that mean? Don’t give up on your dreams just because you can’t do them right now. Master living on less than you make so that down the road you can do absolutely whatever you want with your time. Spend your time picking up lots of transferable skills – public speaking, communication skills, time management skills – that will help you in whatever direction your road goes. Second, retirement planning will move to an even longer scale. Right now, many people calculate their retirement starting at 25 or 30 and ending at 65. The numbers become quite a bit different if you start at 25 or 30 and end at 80. The advantage of starting early becomes even more profound and people won’t have to put away as much each month to hit their numbers. For example, let’s say you need to have $8 million to retire. You start saving at age 25 for that and you’re putting it in an investment that earns 8% a year. If you’re retiring at age 65, you need to put away $2,400 a month. If you’re retiring at age 80, you need to put away only $725 a month. A longer life span means that you can get away with saving a lot less per month for retirement. The power of compound interest is amazing. Finally, don’t bank on the government to save you. I offer this advice to everyone out there still in the workforce. Social Security in its current form is unmaintainable. The numbers do not add up. At some point, it is going to have to be radically changed or it is going to have to disappear. Account for your retirement without Social Security in the equation at all and you’ll find yourself much more secure and happy at retirement time.

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What Does an Extended Lifespan Really Mean in Terms of Retirement Savings?

What YOU Can Learn from Baby-Boomer Blunders

LivingCheaply — Fri, 21 May 2010 10:00:36 +0000

J.D. is on vacation in Alaska. This is a guest post from Neal Frankle , a Certified Financial Planner, and the author of Wealth Pilgrim , a blog about his financial journey. If you know someone in their fifties, don’t be surprised when you discover they’re afraid. I’m 52, and I checked with everyone. They confirmed it. It’s true. Ten years ago, all of our investments were booming: real estate, the stock market, you name it. It looked like we were headed toward retirement heaven. And we had no qualms about spending money we didn’t have. Now, of course, we’re in trouble. The equity in our homes has melted away. Even if we were responsible and didn’t take out home equity lines to pay for trips to the Bahamas and Bahrain, the slide in values has erased a good chunk — if not all — of our equity. Retirement accounts have been shredded twice over the last decade. We’re lucky if we have what we started with ten years ago. Our kids are moving back in with us. Need I say more? We’re older. Besides the obvious depression associated with that, we now have less time to make up for all the money we no longer have. Inflation is just around the bend. How are we ever going to be able to pay for those lattes at Starbucks? Our dreams are now nightmares. We struggle with our money and our marriages. We had plans of early retirement, extended visits to Maui, and long walks along the River Seine. Now, we’re looking at working until we can’t, even if it means punching receipts at the Costco and moving to Barstow. Nothing about this is news to you of course. What might be important, however, is to consider this a “teachable moment”, especially if you’re now in your thirties or forties. I can tell you that when we were in our thirties and forties, we didn’t look to the people 10 to 20 years our senior to try to learn from their mistakes. Don’t make that same error. Specifically, here are the four most important take-aways: Don’t assume your home is going to fund your retirement. It won’t. You have to live somewhere, and your equity may not be as great as you project. If I’m wrong….you won’t complain about it. But if I’m right and you ignore this warning, you’ll be licking your wounds all the way to Costco. Try like hell to pay off your mortgage by the time you’re 55. It may not be possible, but try. If nothing else, it’s a way to force yourself to save. You’ll thank me for it later. Don’t send your kids to schools you can’t afford. Never take on debt to finance Junior’s college or even high school. Don’t count your chickens before they are hatched like we did. We assumed that our investments and earnings would continue to grow so we thought it wouldn’t be a problem to spend that money. We learned how wrong we were. Think about saving as any other expense. Determine how much you need to save monthly and then do it before you spend a dime on anything else. It can’t be an afterthought. Don’t have the mindset of savings “whatever’s left over” because there won’t be anything left over. I’m not wringing my hands, and I’m not trying to criticize you young pups. I think the recent economic turmoil is a fantastic opportunity for everyone to really “wake up”, take notice of what’s working and what isn’t, and then do things a little differently. I’m astounded when I come to work and see people 20 or 30 years my junior who still don’t get this message. I know I’m looking at people who are a bit further down the road to try to learn from them. I don’t think it’s too late. How about you? Have you changed your financial behavior as a result of what you’ve seen others go through? Previously at Get Rich Slowly, Neal has written about finding financial serenity , how to read a mutual fund prospectus , the benefits of starting a side business , and peer pressure and money . — Related Articles at Get Rich Slowly: How I Finally Defeated Dandruff How to Prepare for a Baby (Without Going Broke) Baby Boom: The Shockwaves of a Lifestyle Change Extra Weight, Higher Costs Daily Links: Facebook (and Twitter) Edition

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What YOU Can Learn from Baby-Boomer Blunders

The Snowball: How Compounding Affects Money, Knowledge, and Life

jos — Wed, 12 May 2010 10:00:33 +0000

This is a guest post from Robert Brokamp of The Motley Fool . Robert is a Certified Financial Planner and the adviser for The Motley Fool’s Rule Your Retirement service. He contributes one new article to Get Rich Slowly every two weeks. Happy anniversary to…well, all of us, I guess. This post marks my one-year (and five days) anniversary of being a contributor to Get Rich Slowly . It’s been a hoot. My very first post was a report from my journey to last year’s Berkshire Hathaway annual meeting. While I didn’t attend this year’s meeting, which occurred two weekends ago, my interest in Warren Buffett’s commentary and biography hasn’t flagged. After all, I’m a Berkshire Hathaway shareholder. The wealth snowball This post’s Buffett lesson comes from The Snowball , the recent Buffett biography by Alice Schroeder in which she writes: “Since Warren looked at every dollar as $10 someday , he wasn’t going to hand over a dollar more than he needed to spend.” Buffett apparently was so cheap, he only washed his car when it rained so he wouldn’t have to pay for the water. Former Washington Post heir and publisher Katherine Graham once asked Buffett for a dime to make a phone call. (Before the advent of cell phones, people had to use these things called phone booths if they wanted to make a call in public — and they didn’t even have Twitter !) Buffett only had a quarter, so the billionaire first went to get change. Now, we all know that spending a dollar today means we won’t be able to spend it later. We may also allow that a dollar invested today will be worth more years hence, so that we not only delay gratification — we can pay for more of it. But a dollar saved today leading to $10 someday? That’s an awful lot of compound growth. Yet for Warren Buffett, it turns out that he was underestimating himself. From 1965 through 2009, Berkshire Hathaway stock returned an average 20.3% annually, turning $1 into $4,341. That, ladies and gentlemen, is how you become the richest person in America. Compounding for mere mortals But what about the rest of us? Is it reasonable to think an investment today could decuple ? (Yes, that’s the word for something that has increased tenfold, and, yes, I had to look it up.) That depends on the return you earn, and how long you earn it. Below are three charts, assuming different rates of return, initial investments of $100, $500, and $1,000 (which are more representative than $1 of the spending decisions we make nowadays), and the numbers of years the money is invested. Initial Investment Earns 4% Annually Years $100 $500 $1,000 5 $122 $608 $1,217 10 $148 $740 $1,480 15 $180 $900 $1,801 20 $219 $1,096 $2,191 25 $267 $1,333 $2,666 30 $324 $1,622 $3,243 Initial Investment Earns 6% Annually Years $100 $500 $1,000 5 $134 $669 $1,338 10 $179 $895 $1,791 15 $240 $1,198 $2,397 20 $321 $1,604 $3,207 25 $429 $2,146 $4,292 30 $574 $2,872 $5,743 Initial Investment Earns 8% Annually Years $100 $500 $1,000 5 $147 $735 $1,469 10 $216 $1,079 $2,159 15 $317 $1,586 $3,172 20 $466 $2,330 $4,661 25 $685 $3,424 $6,848 30 $1,006 $5,031 $10,063 In these examples, the only amounts that have increased tenfold are the ones invested for 30 years and earning 8% annually, a return not quite as easy to earn these days as they were in the second half of the last century. Still, the numbers might be compelling, especially for younger folks. A few additional thoughts about these tables: These numbers don’t take inflation into account. So forgoing $100 today doesn’t mean you’ll buy $1,000 worth of goods at today’s prices; it’ll likely be quite less. But as long as you earn a return that exceeds inflation, you’ll still be able to buy more in the future than you could buy today. While most of us don’t drop $100, $500, or $1,000 on purchases every day, I do find it informative (and occasionally painful) to annualize expenses. Spend $6 every workday on lunch? That’s approximately $1,400 a year. Your cable costing you $100 a month? That’s another $1,200. And that’s after-tax money. In other words, to spend that $1,200, you had to earn $1,600 and then pay $400 in federal and state taxes (assuming a 25% combined rate) to have that $1,200 to spend. If you put that money in a traditional retirement account, you can at least defer the federal and state income taxes (though not the FICA taxes — you still have to pay those). The numbers in the charts reflect a one-time investment, and not continual, regular investments. For example, if you invest $500 every month and earn an average annual 6%, you’d have approximately $500,000 after 30 years. If you’re closer to the day you hope to retire than the last time you pulled an all-nighter, you might be saying, “But I don’t have 30 years for my money to grow!” That may be true for the money you need in the first several years of your retirement, but if you live to the average life expectancy (or longer), you won’t touch some of your money until you’re a decade or two into your retirement. Unless you’re an 85-year-old one-armed chainsaw juggler who smokes, you should plan on some of your money being invested for decades. If you, like Buffett, find thinking about future values helps being frugal, print out those charts. Put them in your wallet. Wrap them around your credit cards. Post them on your computer monitor about where the “Place your order” button shows up on your favorite e-shoppe. After all, as Alice Schroeder explained in an interview with The Motley Fool , the power of compounding is where the title of her book comes from: The Snowball is from a saying of Warren’s about life being like a snowball. It is really a metaphor for compounding, for the way that things tend to grow at an exponential rate when they are rolling forward over time. So his money has obviously been like a huge snowball, but it also refers to relationships and to knowledge and all the different things that tend to grow and layer upon each other. Balancing tomorrow and today Despite Buffett’s famed frugality, he doesn’t recommend forgoing all of life’s pleasures. As Schroeder explained in another next segment of her Foolish interview , even Buffett recommended that you have to strike a balance between enjoying today and investing (your bucks or your brains) for tomorrow: He said to me one time, if there is something you really want to do, don’t put it off until you are 70 years old. … Do it now. Don’t worry about how much it costs or things like that, because you are going to enjoy it now. You don’t even know what your health will be like then. On the other hand, if you are investing in your education and you are learning, you should do that as early as you possibly can, because then it will have time to compound over the longest period. And that the things you do learn and invest in should be knowledge that is cumulative, so that the knowledge builds on itself. So instead of learning something that might become obsolete tomorrow, like some particular type of software [that no one even uses two years later], choose things that will make you smarter in 10 or 20 years. That lesson is something I use all the time now. J.D.’s note: While I realize that much of the discussion about compounding involves theoretical, it’s still fascinating. If you start early enough and are disciplined (and things go according to plan), you really can use the power of compounding to build great wealth. But, as Buffett points out, it’s not just money that compounds. Knowledge does, too, as do relationships and experience. The more you do to improve your life today, the better it will be tomorrow. — Related Articles at Get Rich Slowly: Free Debt Snowball Spreadsheet Ask the Readers: How to Prioritize Savings Goals? Daily Links: Compound Interest, Web Income, and Happiness In Praise of the Debt Snowball Daily Links: Question and Answer Edition

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The Snowball: How Compounding Affects Money, Knowledge, and Life

Ask the Readers: Am I Being Foolish for Saving So Much?

LivingCheaply — Fri, 07 May 2010 10:00:07 +0000

Some of my favorite questions come from readers who are worried that they’re saving too much. This is a great problem to have. For example, Henry wrote recently with this dilemma: I’ve been reading Get Rich Slowly since I was 15. At that time, it inspired me to save 20% of everything I earn for retirement. I’m almost 20 now, and I currently max my Roth IRA each year. (Well, I did in 2008 and 2009.) I also take the required percentage to get my employer’s 401(k) match. I also tithe. All of this means that I only take home about 50% of my net (after-tax) income. I currently live at home, and I’ve wanted to move out, but I’ve realized that while I’m saving the money I can’t afford to be on my own. But if I stopped contributing to my retirement accounts, I could. I also want to open a business by the time I graduate from college, and I’d like replace my car (though I don’t really need to). With as much as I save for retirement, I find it hard to save more money for the things I want today. Am I being stupid to save so much money that I can’t touch until I’m 65? First, I want to say that it’s awesome to see somebody so young saving so much money. That’s fantastic. In a society where young people tend to spend much more than they earn, here’s a guy who has made saving a priority. Henry, you’re all right. But what about his dilemma? Is he saving too much? Would it make more sense for a young man to put saving on hold and fund the needs of today? A part of me wants to tell Henry to keep doing what he’s doing: He’s already maxing out his Roth IRA every year and he’s getting the full 401(k) match from his employer. Combined, these two retirement plans will give him a ton of financial weight once the effects of compounding come to fruition in the coming decades. So, one option for Henry is to keep contributing to his 401(k) and his Roth IRA, but to intentionally plan to use future increases in income for his other goals. That is, if he continues his super saving, he can use upcoming raises to get his own place, buy a new car, and start a business. But another part of me wants to tell Henry to seek balance. Money is a tool. It’s there to help you build a life that makes you happy, both today and tomorrow. If he’s not happy today, that’s a problem. The question, then, is how to find balance. Henry needs to be careful not to swing too far the other way. I think it would be a mistake, for example, to stop saving for retirement completely. It’d also be a mistake to begin using debt to finance the things he wants today. How can Henry find balance? What would you do if you were in his shoes? I think I’d try to make small adjustments until I found the balance I needed. He might, for example, pick one of his three goals — moving out on his own, starting a business, buying a new car — and adjust his retirement savings downward in order to pursue it. Or, he could stop contributing to his Roth IRA and use the proceeds to meet one of his goals. Whatever Henry chooses, it’s going to involve trade-offs. That’s one of the realities of personal finance. Though we can generally have anything we want, we can’t have everything we want. Henry is going to have to establish some priorities, and then use his money to meet them. — Related Articles at Get Rich Slowly: links for 2006-11-16 links for 2007-03-29 Nintendo Wii: A Study in Planned Saving Want to Save? Give up the Big Things! How to Turn $500 into $7 the Hard Way

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Ask the Readers: Am I Being Foolish for Saving So Much?