by Joe Hearn | Feb 6, 2012 | Asset Allocation, Debt, Income, Retirement
(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.
by Joe Hearn | Jan 20, 2012 | Distribution Planning, Income, Retirement
Much of your retirement planning will revolve around your retirement budget. It will help determine things like:
- How much you need to save
- When you can afford to retire
- What types of things you can afford to do
- What your income sources will be during retirement
- How sustainable your distribution strategy is
With that in mind, I’ve put together a Retirement Budget Worksheet for you (see link below or visit www.intentionalretirement.com). Use it to begin mapping out your income and expenses during retirement. Feel free to forward it on to friends or family as well.
Retirement Budget Worksheet (PDF)
Thanks for reading. Have a great weekend!
Joe
by Joe Hearn | Dec 16, 2011 | Income, Investing, Retirement
“You’re going to die in 48 hours.” If a doctor gave you that diagnosis, would your plans change for the next two days? Absolutely, right? You would be racing around like a madman (or woman) saying goodbye to family and friends and tying up as many loose ends as possible.
Now imagine that the diagnosis changed from 48 hours to 48 years. My guess is that your sense of urgency just evaporated. No need to rush. There’s plenty of time to live life, spend time with family and work through your “To do” list. That’s because for most things, time and urgency or inversely correlated. That’s just a fancy way of saying that a whole lot of time equals not much urgency and vice versa.
That equation is true in sports, life, deadlines at the office and just about everything else you can think of. Where it doesn’t always hold true, however, is with your money, where less time often translates into less urgency. Given 48 hours to live, I’m guessing money would be the last thing on your mind. You certainly wouldn’t swing by the HR department and increase your monthly 401(k) contributions. But that is exactly the kind of response you should have after learning that you have 48 years to live. The more time you have (i.e. the longer your life expectancy), the more money you will need and the more urgent it becomes to be saving as much as possible. So if you plan on living for awhile, hurry up! You have a lot of time and there isn’t a minute to waste.
A few practical applications:
- Automate your savings in 2012 by having money automatically taken from your paycheck or checking account each month.
- Calculate what you saved this year and increase it by 1% next year. If possible, do the same every year after.
- If older than 50, take advantage of the catch-up contributions allowed on your 401(k) and IRA.
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by Joe Hearn | Oct 31, 2011 | Estate Planning, Income, Retirement
I spent a lot of time traveling in October, which was good for my tan, but bad for my writing schedule. There’s quite a bit on the editorial calendar for November though, so stay tuned. In the meantime, below is a list of articles published at Intentional Retirement during October.
Thanks for reading!
Joe
by Joe Hearn | Oct 18, 2011 | Income, Retirement, Social Security
Here it is:
Every year during retirement, everything you buy will cost more than it did the year before.
Such is the nature of inflation. In 1990 a stamp was 25 cents. Today it has almost doubled to 44 cents. A gallon of gas was $1.16. Today you can expect to pay triple that. A new home in 1990 was $149,800. Today it is…well, let’s just say housing has hit a bit of a soft patch.
Multiply those increases across all the goods and services you buy during retirement—dinner out, a new car, a vacation—and over a 20-year retirement, you can expect prices to more than double (assuming 4 percent annual inflation). That means you’ll need twice as much income later in retirement to buy the same goods and services you bought at the beginning of retirement.
How can you combat this nemesis of inflation? Most people’s retirement income comes from two different sources: Social Security and personal savings. Let’s look at ways to overcome inflation in each.
Social Security
Social Security has a built in annual cost of living adjustment, so most people assume that it will keep pace with inflation. Unfortunately, that may not be the case. Social Security adjustments are based on the Consumer Price Index or CPI. For decades, the Bureau of Labor Statistics (BLS) calculated the CPI in a fairly straightforward manner. They looked at a basket of goods, and determined how much it would cost. The following year they would price out that same basket of goods and the CPI would go up or down based on the new price.
In the 90s, some in government began to argue that inflation was overstated. They argued that as prices increased people would substitute less expensive alternatives, so the “basket of goods” should be adjusted each year. If steak got too expensive, they assumed that consumers would substitute something cheaper like hamburger. So why not remove steak from the basket, put hamburger in and voila, inflation is under control. Rather than implementing this “variable basket”, the Clinton administration implemented a different process that essentially achieved the same results. The BLS began to weight items in the basket differently. Basically, items that were increasing in price were given less weight than items that were decreasing in price.
To make matters worse, the BLS went on to make another change based on what they called “hedonics.” In short, hedonics doesn’t simply consider the price of an item, but the value that you get from that item. So if the price of a new car increases 10 percent, but there are new features on the car like airbags or heated seats that increase the “value” to the consumer by 15 percent, then the BLS would essentially say that the price of that car had decreased by 5 percent even though you’re paying more for it.
Applying this to your Social Security check, you can see that the annual cost of living increase built into the program won’t necessarily help you to keep pace with inflation if it is based on the fuzzy math of the CPI. A case in point: there were no cost of living adjustments in either 2010 or 2011, even though prices for things like food, fuel, and medical care undoubtedly increased over that period.
The solution:
The best way to overcome this hurdle is to build your own inflation factor into your Social Security benefits. How do you do that? Rather than waiting until full retirement age or later, the average person retires at 62 and takes a roughly 20 percent permanent reduction in benefits. Rather than following their lead, if you wait a few years you can retire on full benefits. Even better, retire a few years “late” and you can add as much as a third to your annual benefit (8 percent per year for those born after 1943 to a maximum age of 70). The annual cost of living adjustment will still be understated, but it will be based on a much higher benefit amount.
Personal Savings
In the same way that inflation eats away at the value of your Social Security income, the purchasing power of your savings and investments are also constantly being eroded. Failure to keep pace will result in your money becoming worth less until it is eventually worthless. As we saw earlier, even a modest rate of inflation of 4 percent can wipe out nearly all of the purchasing power of your nest egg during a 20-year retirement.
To overcome this problem, you need to invest in things that have the possibility of outpacing inflation. Understandably, however, the volatility and uncertainty of the last few years has caused many to shift their investments into things like money markets, certificates of deposit (CDs) and other “safe” investments.
Unfortunately, safe can be risky.
Consider a day in the hospital. In 1980, a day in the hospital cost $344. Today that same day costs around $5,310 (according to statistics published by the Wall Street Journal). For the sake of our example, let’s assume that 30 years ago you wanted to start planning ahead for your retirement. You thought that someday you might end up in the hospital for an illness and you wanted to set aside enough money to pay for a two-week hospital stay. You didn’t want to risk losing the money however, so you just put the cash into your safe-deposit box.
Fast forward three decades and you’re hospitalized with pneumonia for two weeks. When the bill arrives, you remember the cash that you stashed away so many years ago. You make a trip to the bank, open the box, and find exactly $4,816. Looking at the bill, you realize you’re about $70,000 short. By not outpacing inflation, your money lost almost all of its purchasing power.
Now let’s assume that instead you invested that $4,816 into the S&P 500 back in 1980. Even with all the ups and downs, it would have grown to nearly $135,000 by 2011. That’s enough to pay your entire hospital bill with plenty to spare.
The solution:
So what are some ways to preserve the purchasing power of your nest egg? First, as we just saw, you should resist the temptation to be too conservative. You aren’t doing yourself any favors by having a portfolio dominated by “safe” investments like cash, government bonds and CDs. These investments are less likely to outpace inflation and could even lose a significant amount of their value during high inflationary periods. Most investors should keep at least a portion of their investments in quality stocks.
Second, consider investments in real estate, commodities or precious metals. These types of “intrinsic value” investments tend to do well during inflationary times. As we have seen with the current downturn, however, they can also be more volatile and less liquid than stocks and bonds, so keep that in mind.
Finally, consider investing in a real return mutual fund. These funds invest in a wide range of investments that are designed to battle inflation, such as inflation protected treasury bonds, real estate investment trusts, floating rate bonds, non-U.S. debt, natural resource stocks, high yield bonds, currencies and commodities.
Clearly, a fixed income retirement strategy in a rising cost world is a recipe for running out of money. By investing in a well balanced portfolio that is designed to keep pace with inflation, you can help ensure that your money not only lasts for your lifetime, but also provides you with the income necessary for security and independence during retirement.
Thanks for reading. Touch base if I can ever help.
Joe
