The amount of debt in the world is staggering.
- Auto loans recently passed $1 trillion for the first time and the average car loan is the highest it’s ever been, recently surpassing $30,000.
- Student debt stands at about $1.4 trillion.
- Mortgage debt is about $14 trillion.
- More than 30% of households carry a balance on their credit cards. Those that do have an average balance of $16,000
- The top 2,000 non-financial companies have $6.64 trillion in debt, $2.81 trillion of which they’ve added in the last five years.
- The U.S. public debt has nearly doubled since the 2008 financial crisis, ballooning from $10 trillion to more than $19 trillion.
- 20 years ago China had $500 billion in public and private and debt. Ten years ago that number stood at $3.5 trillion. Today it is more than $35 trillion.
More than the amount of debt, however, is just how much of it has been added since the 2008 financial crisis. After experiencing a debt induced financial Armageddon, you’d think individuals, companies and governments would be hesitant to go down that road again. Not so. Record low rates have fueled trillions (with a “T” like the Titanic) in new debt. It’s like eating until you’re sick at a buffet and then deciding that the next logical step is to grab a new plate and see how many cheese enchiladas and Mini BBQ Brisket sandwiches you can fit on it.
And just like binging at the buffet is likely to end badly, binging on debt will usually end in a combination of regret and real world consequences. How is all this debt affecting us and our ability to reach our retirement goals?
It’s causing stress. A recent survey of adults with student loan debt showed that people would go to some pretty extreme lengths to get rid of that debt. Nearly 57% would take a punch from Mike Tyson. More than 40% would give up a year of life expectancy. Almost 7% said they’d be willing to cut off their own pinky finger. Think about that. A not insignificant percentage of the borrowers polled would be willing to die sooner or hack off body parts if they could turn back time and get out from under their debt. Living with excessive debt is stressful.
It’s making us financially fragile. A recent Federal Reserve survey found that 47% of Americans could not cover an unexpected $400 expense without borrowing or selling something. In other words, half the country is stretched so thin that they couldn’t afford a car repair or a new pair of glasses without some sort of payment plan. There are likely many reasons for this state of affairs, but one is most assuredly debt. In other words, we need to go into debt to fund new purchases because all of our income is already being used to pay for the debts from our old purchases.
It’s limiting our ability to save for retirement. Each year the Employee Benefits Research Institute (EBRI) conducts a Retirement Confidence Survey to see how people are doing when it comes to saving for retirement. In the most recent survey, nearly a third of respondents reported having less than $1,000 saved so far. Two-thirds have less than $50,000 saved. You don’t need to be a financial genius to know that $1,000 is not enough to fund a 20 or 30 year retirement. Even $50,000 would only get you a year or two at best. Why aren’t we saving more? Again, one reason is debt. If most of your current money is being used to pay for past purchases, you won’t have much left over for future savings.
It’s exposing retirees to market risk. Even if you are near retirement and you have no debt, you may still be at risk from debt indirectly. That’s because, with interest rates so low, many retirees have been forced to move further up the risk spectrum to get any sort of yield on their investments. It used to be that you could put your money in a risk-free money market and earn 3%. Now those same investments pay 0%. Super safe bonds don’t yield much better, so many investors are shifting more of their portfolio to lower quality bonds or dividend paying stocks. That works fine while markets are rising, but if we get another debt shock and borrowers can’t repay, then markets could tumble and many investors may find that they took on too much risk in their search for yield.
How much debt is ok?
To be sure, not all debt is bad. Debt can be a useful tool when it’s used to purchase an asset or invest in a project that helps us to generate income and pay back the debt. That said, in order to retire comfortably, the typical person needs to move from a place of low savings and high debt early in their career to a place of high savings and low debt later in their career.
What should that gradual reduction look like? To help people track their progress, researcher Charles Farrell devised a Debt to Income Ratio and then established benchmarks for different age groups. According to Farrell, your debt (e.g. mortgage, car loans, credit cards, etc.) divided by your income should be 1.25 at 40, .75 at 50, .20 at 60 and zero at retirement.
Retiring debt free used to be the rule rather than the exception. Unfortunately, that is no longer the case. In fact, a recent study by the Employee Benefits Research Institute showed that 65 percent of American families with a head of household age 65-74 had debt. The age group with one of the biggest spikes in debt was 75 and older.
That’s troubling because debt adds risk and reduces cash flow, two things that can derail your retirement. It is inherently limiting at a time when most hope for greater independence and opportunity. It increases uncertainty at a time when most people want security. So make a plan to gradually eliminate your debt and you will greatly increase your odds of having freedom, flexibility and peace of mind during retirement.
Let’s take a poll. What do you think will be your biggest retirement expense? Travel? Healthcare? Plaid pants? Mai Tais?
Actually, according to a recent report by the Employee Benefit Research Institute (EBRI), you’ll likely spend the most (40-45% of your budget!) on housing. That’s right. The Casa. Good old home sweet home. Nearly half of your income will likely go to cover things like your mortgage, taxes, utilities, and maintenance.
For some reason this doesn’t sit well with me. Just like the argument for life insurance becomes less compelling as we age, it would seem to me that the argument for spending the lion’s share of your budget on housing becomes less compelling as well.
Yes, there was a life stage where it made sense to spend heavily on housing. You hadn’t saved much and needed to borrow. You needed space for a growing family. You wanted to be near good schools. A nice house was comfortable and conveyed a certain amount of status. But are those reasons as compelling in retirement?
After the EBRI report came out, most articles I read on the subject focused on how retirees could cover such a large expense. But what if you reframed the debate from “How?” to “Why?” WHY spend such a large portion of your income on shelter? Especially during retirement. Every dollar you spend on shelter is a dollar that you’re not spending on travel, hobbies, and other pursuits that provide meaning, purpose, fulfillment, and enjoyment.
Quick Note: I am NOT saying that having a nice house in retirement is bad. Some have their house paid for and it’s a low cost option. Some can totally afford a nice house without it impacting their other plans. For some, the house IS their plan (e.g. a place for kids and grandkids to gather, a neighborhood close to friends, a place to entertain, etc.). The only time where an expensive house might become a problem is when the costs associated with it prevent you from being able to afford the things you really want to do in retirement. If that’s the case, I think it’s worth considering alternatives.
With that said, I’d like to ask you three questions that will hopefully challenge your thinking on your house and just might lead you to pare back your spending on shelter so you can maximize spending in other areas that matter more to you.
Question #1: What would it take to pay off your house before retirement?
One way to reduce your housing expense would be to outline a plan to have your house paid off by the time you retire. You’ll still have expenses like taxes, insurance, and maintenance, but you’ll no longer be paying principal and interest on a loan. Here’s a post that will walk you through how and why to retire debt free. And if you want to play around with different payoff scenarios and run some amortization schedules, the app “Debt Free” is helpful and simple to use.
Question #2: Would your retirement be better if you made a conscious effort to downsize and simplify?
A few months ago I interviewed Joshua Becker of Becoming Minimalist (you can listen to the full interview here). We talked about ways that you can simplify life, minimize stress, and focus on what you really want out of life and retirement. One of those ways was to declutter your house and possibly even downsize to something smaller. This frees up time and money to focus on other priorities. If simplifying sounds appealing, check out the Intentional Retirement Pinterest Page where we have boards for things like cooking for two, tiny houses, and the art of simplification.
If you want to go one step further, I personally think it’s worth at least asking if homeownership still makes sense for you during retirement. Taking care of a house is more difficult as you age. You don’t have the same space needs. It ties up a huge chunk of your nest egg. If you compare owning vs. renting, you might find that owning is not the “no-brainer” that it was during your working years.
Question #3: What if you redefined status in retirement?
Let’s be honest. Our culture confers a great deal of status based on things like homes and cars. It’s easy to get sucked into that game. Especially when banks are more than willing to put you in debt up to your eyeballs so you can make a good showing for the neighbors.
What would happen if we started to buck that trend? What if, instead of the currency of status being “stuff”, we started to make it travel, purpose, time with family, happiness, and freedom.
A year or so ago I read about a couple living in California who spent about $7,000 per month on housing, cars, groceries, eating out, entertainment, and vacations. They wanted a bit more adventure during retirement, so they sold the house and cars and hit the road with the goal of extended stays in interesting places for the same or less than what they were spending in California. They stayed several months in London for $6,800 per month. Florence and Paris were a bit less at $6,050 and $6,550 respectively. Buenos Aires was a comparatively modest $4,400 per month and Mexico was practically a bargain at $3,450 per month.
Is this for everyone? No. Should we do those things simply for the status associated with them? Definitely not. Climb the mountain so you can see the world, not so the world can see you. But if we’re going to admire people for something, we could pick worse criteria than looking up to those who live a full life.
Bottom line – think through what’s important to you during retirement. What do you really want to do? Once you have that list, invest heavily in those things. If your house is on the list, great. If not, don’t allow it to consume most of your resources at the expense of everything else on your list.
Photo by Joe Hearn.
“When can I retire?” I get that question a lot. If you’re curious about the answer, look no further than your retirement budget. The more money you want to spend during retirement, the more you’ll need to save before you get there and the longer you’ll likely need to work. It stands to reason then, that you can probably retire sooner if you can figure out a way to spend less during your golden years. What are some ways to downsize your expenses without downsizing your dreams for retirement?
It has almost become dogma over the last decade that financial security comes by giving up things like your daily latte. That advice can certainly help you sock away a few extra dollars over the years, but if you’re getting close to retirement and find yourself tens (or hundreds) of thousands of dollar short of your goal, drinking Folgers instead of Starbucks isn’t going to solve your problem. It’s just not a big enough line item in your budget. If you want to make a big impact, you need to focus on big expenses.
According to a recently released report by the Social Security Administration, the two biggest expenses for most retirees are housing (35 percent) and transportation (14 percent). Said another way, almost half of your retirement budget will go to pay for the roof over your head and the vehicles in your garage. Let’s look at an imaginary couple to see how cuts in those areas can make a big difference.
John and Linda would like to retire next year. They decide to hire an adviser to look over their plan and, much to their dismay, the adviser tells them that they need to save another $300,000 to adequately fund their retirement. At the rate they are saving that would mean delaying retirement for another 10 years. Instead, they look at their retirement budget for ways to cut back.
With the kids gone, they have more space than they need, so they sell the house for $250,000, move into a $150,000 condo and pocket the extra $100,000. With carpooling and soccer games a thing of the past, they trade in their SUVs on two smaller cars (net gain $20,000) and even kick around the idea of sharing a car once neither of them is working. The smaller house and more fuel-efficient cars also means that they’ll be spending about $500 less each month ($6,000 per year) on taxes, utilities, gas and maintenance. Assuming a 4 percent withdrawal rate, that $6,000 annual savings means that they can get by with $150,000 less in their nest egg.
The total benefit, then, from cutting back in just those two areas was $270,000 (or 67,500 lattes). Not bad. They still have $30,000 to go, but at the rate they’re saving they should be able to set that aside and still retire next year as planned.
[Note: To consider ways to trim your own budget, you can download a free retirement budget worksheet at www.intentionalretirement.com/budget.]
Another way to increase retirement security and perhaps even retire sooner than expected is to eliminate debt. It used to be common for people to enter retirement with little or no debt. Unfortunately, that is no longer the case. According to a recent study by the Employee Benefits Research Institute, 65 percent of American families with a head of household age 65-74 had debt. The age group with one of the biggest spikes in debt was 75 and older.
Not surprisingly, debt makes it harder to fund your retirement. It cuts into your cash flow and increases the risk that you will run out of money. Again, let’s assume that you can draw 4 percent per year from your assets during retirement. That means that for every $1,000 in annual income that you want during retirement, you’ll need $25,000 in savings.
Look at your current budget. How much do you spend each year on debt payments (e.g. mortgage, car, credit cards)? Multiply that number by 25. How much is it? $250,000? $500,000? More? That’s how much you’ll need to save in order to service that same amount of debt in retirement. As you can see, retiring will be much easier if you retire your debt first.
So as you plan, don’t think of retirement as a particular age or work status. Think of it as the time in your life when you can afford to pay your bills through means other than your job (e.g. personal savings, pension, Social Security).
When you look at it that way, it becomes clear that you can reach your retirement goals from two different directions. “Save more for retirement” is certainly one way, but “spend less in retirement” can be just as effective.
Note: I first published this article in the Omaha World Herald.
Just like it’s a good idea to get a health checkup every year, it’s a good idea to get a financial checkup as well. Doing so can help you detect problems early (while they’re still treatable) and will also help you gauge your progress and make sure you’re on track for a healthy retirement.
To help, I put together this Financial Checkup Checklist with areas that you should be reviewing. Go through it and then touch base with me if you have any questions or there’s anything I can help you with. Have a great week!
Well, another year is in the history books. Where does the time go? It seems like just yesterday that I was singing along to Prince’s “Party Like It’s 1999” and worrying that my coffee machine was going to be a victim of Y2K and here we are a “Baker’s Decade” into the new millennium.
As the years go by, I, along with millions of others, find the idea of retirement morphing from a vague concept to an impending reality. The signs are subtle at first. An AARP magazine in the mailbox. A “take this job and shove it” daydream at work. A lingering glance at the orange and red sections of the USA Today weather map. If retirement looms large on your horizon, then there’s no time to waste. Below are 7 resolutions for the New Year to make sure that your planning is on track.
Recalibrate after the “Fiscal Cliff.” As the dust settles in Washington, there are several variables in your retirement plan that you may want to review. In particular, any changes in your tax bill can affect everything from your planned retirement date to your distribution strategy. Entitlement reform was delayed (color me surprised!), but any eventual changes to Medicare and Social Security will also affect your retirement. Schedule a meeting with your adviser to factor in these new variables and make sure that your plans are still realistic.
Increase your contributions. Are you getting a raise in 2013? Sure you could use that to upgrade your iPad or buy tickets to the soon to be announced Rolling Stones tour, but a third option would be to route that extra cash into your retirement accounts. Contribution limits for 2013 are increasing to $5,500 (plus an additional $1,000 for those over 50) for IRAs and $17,500 (plus an additional $5,500 for those over 50) for 401(k)s.
Create a debt payoff plan. If you subscribe to the 4 percent withdrawal rule, then for every $1,000 in income you need to generate during retirement, you’ll need $25,000 in assets. Doing some simple arithmetic, it’s easy to see that retiring with a mortgage, car payment or other debts can add hundreds of thousands of dollars to your “Number.” Reduce that burden by committing to a plan to retire debt free.
Get on the same page with your spouse. Try this experiment. At the dinner table tonight say “I can’t wait to retire in 2016 so we can move to San Carlos, Uruguay and I can realize my dream of becoming a real life gaucho.” The response that you get will show you how important it is to be on the same page with your spouse when it comes to your retirement planning. Now that the conversation is going, spend some time talking through your hopes, dreams and plans so that you can iron out any differences and compromise on a plan.
Take a mini-retirement. You wouldn’t want to get all the way to Uruguay only to second guess the whole gaucho thing. As you get closer to retirement, you should start using whatever vacation and sick time you have to test drive your plans. A mini-retirement is a great way to learn more about a place or to experiment with your retirement budget. Use what you learn to refine and improve your plans.
Set aside your first year of expenses. In case you hadn’t noticed, the financial markets have been a bit—what’s the word?—schizophrenic the past decade or so. If retirement is just around the corner, you run the risk of having to withdraw money from your nest egg at a time when your investments are performing poorly. Experts refer to this as sequence risk. To avoid that problem, set aside one year of your retirement expenses in cash. If the markets are doing well, you can draw income from your investments. If markets are doing poorly, you can draw from your cash and give your investments a chance to recover.
Update your estate plan. Estate and gift taxes were scheduled to change drastically in 2013, but got a last minute reprieve with the deal in Congress. The estate tax rate increased to 40 percent from 35 percent, but other than that, most existing estate tax rules were made permanent. Work closely with your attorney and financial adviser to make sure that your plan is up to date and designed to minimize taxes. Also be sure to have a strategy in place to cover any potential liability (e.g. life insurance) and make sure that your beneficiary designations and powers of attorney are up-to-date and reflect your wishes.
That list of resolutions makes me long for the days of simpler goals like “join a gym” or “quit smoking.” But hey, no one said retirement was going to be easy. If it was, the world would have more gauchos.
I originally published this article at www.marketwatch.com. Photo by Sacha Fernandez. Used under Creative Commons License.
(Note: This is Part 2 in a three part series that I did for the Omaha World Herald on retirement planning for different life stages. I’m re-posting it here for all of you who don’t live in snowy, freezing Omaha!)
Forty-five is an interesting age. It’s like the Junior High of aging. Too old to fit in with the kids at the Kanye West concert, but too young for the senior discount crowd at Denny’s. Exactly halfway between 25 and 65, it’s like a weigh station between the carefree and exciting days of your 20s and what will hopefully be the carefree and exciting days of retirement.
With 20 years to go, it’s a good time to reflect on the planning you’ve done so far and see if you are on the right track. If not, you’ve still got time to do something about it, but the clock is ticking. Here are 20 ways to make sure you’ll have enough in 20 years.
1. Actually figure out what you need. Too many people retire based on their birthday instead of their bank account. Knowing how much you’ll need will help you save with purpose and intention. A good rule of thumb is to shoot for a nest egg that is 25 times larger than the amount you want to take from it each year.
2. Get out of debt. No one in the history of the universe has gotten rich spending money they don’t have on things they don’t need. You won’t be the first to crack the code.
3. Perform budget triage. Most budgets don’t bleed to death from a gaping wound, but rather a thousand little cuts. Wasting $20 per day for 20 years will shave about $334,000 from your nest egg (assuming an 8 percent annual return).
4. Beware any sentence that begins with “Hey dad. Can I…” People in their teens and twenties are incapable of ending that sentence with anything that doesn’t cost you money and put a hole in your nest egg. Whatever the request, just answer with a firm “Yes, as long as I can move in with you in 20 years because I had earmarked that money for retirement.”
5. Make your saving automatic. Saving is like going to the gym or eating your vegetables. You know you should do it, but it takes discipline. Make it easy on yourself by having money automatically deducted from your checking account or paycheck each month.
6. Focus on the basics. Saving and investing doesn’t need to be complicated. You can contribute $17,000 to a 401(k) and $5,000 to an IRA each year. Start there. Maxing out your contributions for 20 years would add about $1,006,000 to your nest egg (assuming an 8 percent annual return).
7. Refinance. Interest rates are at historic lows. If you still owe money on your house, consider refinancing into a loan with the same payment, but a lower rate and shorter term. You’ll save thousands in interest and you’ll enter retirement with no mortgage.
8. Get healthy. In 1900 the three leading causes of death were influenza, diarrhea, and tuberculosis. Today they are heart disease, cancer and stroke. All three of those diseases are expensive (even with insurance) and heavily dependent on things like diet, exercise, smoking, drinking, and stress.
9. Beware midlife crisis purchases. If you’re tempted to buy a Hemi powered midlife crisis-mobile, don’t. Buy a nice used grocery getter instead and put the difference in your IRA.
10. Add up everything you’ve spent during the last 12 months on beverages (e.g. soda, red bull, alcohol, venti non-fat no foam double shot hazelnut lattes, etc.). If the number is greater than the world median annual income (about $1,700), reacquaint yourself with the benefits of water.
11. Make it personal. You’re not planning “retirement,” you’re planning “your retirement.” Once you realize that and spend some time thinking about the things you are really looking forward to, you’ll be incredibly motivated to make it happen.
12. Avoid mistakes, especially those that result in large investment losses. At 20 you had plenty of time to recover. At 45, large losses are like meteors to dinosaurs. They are extinction level events. Don’t put all your eggs in one basket (like your own company’s stock) or make questionable investments (like that can’t miss tip from your brother-in-law).
13. Meet with a trusted adviser annually. Answer three key questions at each meeting: How did my investments do this past year? Am I still on track for retirement (see number 1)? What changes do I need to make?
14. Work on your marriage. Middle age is a risky time for you and your spouse. Having a happy marriage is reason enough to put forth the effort, but if you need something more, remember this: A sure fire way to derail your retirement is to divide all your assets in half.
15. Don’t be too conservative. The markets have been crazy these last few years and a lot of people responded by moving everything to cash. That may help you sleep well, but it won’t help you grow your assets and outpace inflation. Repeat after me: Safe is risky.
16. Review your asset allocation. If instead of moving to cash, you ignored your investments through the recent market turmoil, there’s a good chance that the ups and downs threw your portfolio out of balance. Research shows that your asset allocation is responsible for 90 percent of your investment returns. Work with your adviser to rebalance to a more appropriate allocation.
17. Downsize. Once the kids are gone, reconsider the necessity of having a house big enough to have its own gravitational field. A smaller place means that you’ll be spending less on your mortgage, heating, cooling, insurance and property taxes. Invest that savings for retirement.
18. Take advantage of peak earning years. You’ll likely make a lot of money in your 40s and 50s. As the kids grow up and move on, be sure to make your peak earning years your peak savings years as well.
19. Beware of fees. A good adviser or mutual fund can add value, but pay close attention to the fees you are paying. It’s not just the fees, but the compound interest those fees would have earned had they stayed in your account. Over a 30 year period, an extra 1 percent in fees is enough to shave 25 percent off the ending value of your investments.
20. Don’t retire early. Calling it quits before your full Social Security retirement age could mean a 20 percent permanent reduction in benefits. It’s worth remembering that the number one reason people retire early is poor health (see number 8).
Unless you’re a trust fund baby or a lottery winner (and let’s be honest, they all quit reading after number 3), you’ve probably got a little work to do. But have no fear. You can do a lot in 20 years. The key, as with most things, is to start. Ready? Go.