Archives for planning category
1
Jan
Posted in planning by Roger |
Happy 2010, everyone! It’s a whole new year now, and now that the calendar has rolled over, most people are looking to find ways to improve their lives this year. That’s right, it’s resolution season once again, when we promise ourselves that we’re going to get back in shape, be more diligent about cleaning, spend more time with our families, and get our financial ship in order.
I’m no different, now that it’s 2010, I have a whole list of things that I need and want to do to improve my life. Luckily, to help keep myself motivated and on track, I have this blog and my wonderful readers. If I have all my desired goals written down, review them regularly, and hold myself accountable to both me and all of you, I’m sure that I’ll be much more motivated and dedicated to reaching my goals, however hard they may seem. With that in mind, let’s get to my goals:
When the fireworks are gone, the real work begins
Goal #1: Go back to Grad School
My Reason: I’ve been considering furthering my education for quite a while now. Besides being one way to get more out of my career, it’s also a requirement if I hope to eventually become a university professor (which is something I’ve wanted to do for quite a while now). Better to do it now, when I have few responsibilities or previous commitments to tie me up.
The First Step: Getting into school. I can’t attend if I’m not a student, so my first step has to be to do whatever I can to make it into a good school and continuing my education.
Microsteps (Tiny steps I’ll use to make it towards my goal): 1. Do research into several (around four or five) good grad schools in the area, to narrow down my list of potential places to apply and eventually attend.
2. Start to contact these grad schools, to clarify what is required to apply (especially since most places have the application due near the end of January or so).
3. Apply to every school on the list where I meet all the requirements currently, as soon as possible.
4. Work on meeting the requirements for all the other schools. From my preliminary research, this is going to involve taking the GRE (either the general form and the specific subject tests for my major, or both, depending on the requirements of the school). Which brings me to my next point:
Goal #2: Take the GRE Examinations
My Reason: As mentioned above, the Graduate Record Examinations (GREs, for short) seem to a major key to getting into a good grad school and meeting the rest of my first goal, so I’m going to have to take the appropriate GREs soon if I hope to make it into graduate school.
The First Step: Preparing for the test. It’s been a while since I’ve graduated from college, and as much as I’ve tried to retain what I’ve learned, there’s only so much you can recall if you don’t have to use your knowledge regularly. Since most of my jobs since college have required me to use only a fraction of what I learned in my classes (and frequently a fraction that doesn’t seem relevant to these examinations), it’s going to take quite a bit of preparation to get me back in shape.
Microsteps: 1. Determining what’s on the test. Luckily, there are plenty of practice tests out there (including examples provided by ETS itself), so I should be able to get a good idea of what subject matter will be included.
2. Study, study, STUDY. I have quite a lot of work to do to get my mind back into peak test taking shape. Luckily, I was (and still am) a bit of a hoarder back in college, so I still have many, if not most of the relevant text books, which will make it easier, and much less costly, to get my mind back into shape.
3. Sign up for the test. I can’t forget to schedule myself to take the test sometime in the not too distant future. No sense working so hard to master the material if I never get to show off my stuff.
4. Take the practice tests. Luckily, there seem to be plenty of example tests, both online and in print, which will help me prepare for the GRE Subject Tests as well as the general test. I’ll probably take them like I did with the practice tests in my various classes in college; one a week or so before the scheduled test, to see what I still have to learn, and then two to three days before the test, to see if I have learned it all (and see what should occupy my last minute studying time).
Goal #3: Rebuild My Emergency Fund
My Reason: With my second long period of unemployment within one year, I’ve all but depleted my emergency fund, and need to rebuild it. It’s been a long time since I’ve been quite so low on funds, and if things take a turn for the worse (knock on wood; I’m not sure I can handle if things get worse), I need to be prepared.
The First Step: As with saving for anything, the first step is simply to start setting money aside and do everything I can avoid touching it. There’s nothing really tricky about it, but it requires time and dedication.
Microsteps: 1.Stop tapping into my remaining emergency funds. This should be pretty easy; I’ve all but tapped out my emergency accounts already, so it’s going to be pretty hard to take any more out.
2. Start putting a portion of any income (from unemployment, my future job, or heck, even blogging), and put it into a high yielding savings account. I’ve been trying to do so whenever I was employed, but with my lack of work as of late and various problems with unemployment, I’ve been taking money out more than putting it in. That’s got to change.
3. Cut down on my spending. An important part of any saving plan is to reduce your spending (a penny not spent is a penny saved, or something similar).
4. Don’t touch the emergency fund. Probably the most important part of rebuilding the fund is not to touch it; if I keep pulling money out the moment it actually starts to add up to something, I’ll never have a decent emergency fund. Adding money and not taking it out; that’s all there is to saving.
There; my resolutions for 2010. What have you resolved to do? Any advice on completing these or other resolutions? Has anyone gone more than two months into a get thin/exercise more/become fit resolution before they just gave up?
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3
Dec
Posted in planning by Roger |
One of the articles that was submitted for the latest Carnival of Twenty-Something Finances took a rather pessimistic view of the economic future, particularly when it came to the current political climate. As I mentioned in that carnival, I don’t particularly agree with everything that My Wealth Builder thinks will occur, but I still think it’s important to be aware of such predictions and prepare for the worst. So, I’m going to review his predictions in more detail, looking at how likely I believe they are to occur, what to do to prevent suffering too much if they come to pass, and how to make sure you don’t lose your shirt if he just happens to be wrong. Let’s begin:
Prediction #1: High Inflation
How Likely is It: Given that we’ve been suffering (if that’s the right term) from deflation for most of the year, we’re definitely due for higher inflation when the people begin spending and banks begin lending again. How much inflation, and whether it qualifies as high, will depend on how well the government adjusts once the economy starts to heat up. I’m guessing we’re in for at least a few years of higher than normal inflation before everything finally settles out.
What if It Happens: There are several good ways to invest in order to fight inflation, some of which I’ve covered already on this blog. The short list includes stocks, Treasury Inflation Protected Securities (TIPS), and I-bonds, the last two being special types of government bonds. You could also invest in commodities and real estate, although they will not be as explicitly an inflation defense.
What if It Doesn’t Happen: If we aren’t hit by high inflation, you can do much the same thing: a diverse portfolio, with plenty of stocks and/or inflation protected bonds, is always a good idea.
Prediction #2: Higher Health Care Cost, Lower Quality
How Likely is It: To be completely honest, I don’t know. The health care reforms in this country are still being debated in the broadest possible terms, with no agreement on what the health care system will look like after the dust settles. I’m trying to be optimistic about the final bill that results, but I will admit that even the best designed bill may fall apart in practice. But, isn’t that always the way?
What if It Happens: Again, without knowing what the future of health care will look like, it’s hard to give solid advice. I doubt that private health insurance plans will disappear overnight, so even if your employer decides to drop your coverage, you can probably still find a health insurance plan that offers significantly more features than a government plan (assuming that a single-payer or other government controlled plan actually is in the final package). In that case, you may find yourself choosing between an inexpensive but less desirable government plan or an expensive, better private plan; which one you choose will depend on your resources and priorities.
What if It Doesn’t Happen: It’s possible that health care reform can make the health insurance environment simpler, easier to understand, and cheaper. (Don’t laugh, it’s possible.) In that case, you may find yourself with cheaper, better coverage than you have now, and you won’t need my help.
Prediction #3: Taxes Will Be Higher for Everyone
How Likely is It: This is the one on which I’m most torn. On one hand, we here in the US have a large and steadily increasing national debt, which will need to paid off (or at least scaled back) at some point in the future. To do that will require cutting spending (which is easier said than done, as everyone wants to reduce spending until a program that gives them money is on the chopping block), raise taxes, or mostly likely, doing both. On the other hand, no less than Jack Hough of SmartMoney argues in the December 2009 edition that compared to other developed nations, our national debt is affordable and under control. So, until I start reading news that say, Japan has declared bankruptcy, I’m going to say that the government is going to hold off on raising taxes (at least for all but the top percentage of earners or so) for quite a while (probably not until Obama’s second term or so).
What if It Happens: If I’m wrong and taxes do go up in the near future (or I’m right and you just happen to be in the top tax brackets), there are a number of ways to hedge your taxes. Adjusting when you make charitable contributions, how much you contribute to your retirement accounts (as well as whether you choose a pre-tax or post-tax style account) and what type of investments to choose will all affect your tax bill. Taking the time to carefully look over your tax return as well as consulting with an accountant or other professional will be even more worthwhile if you find yourself facing higher tax rates.
What if It Doesn’t Happen: Well, even if tax rates don’t rise, you’ll still have to pay some taxes. (They’re as inevitable as death, after all.) So much the same suggestions still apply; study the tax laws, for the nation, the state, and your city, if applicable, and do what you can to manage your tax burden.
Prediction #4: Recession Recovery Will Be Slow
How Likely is It: Well, if you ask economists, the Great Recession has already concluded and we’re in the recovery stage already. Of course, from a jobs perspective, things are significantly bleaker. With unemployment hovering around 10% (and even that figure does not include things like underemployed people and others who have given up on searching), there’ s a high number of people who still have a lot of recovering to do. Personally, while there are parts of the economy that are making an improvement, I think that there’s a way to go (and not too much that the government can do, in spite of their best efforts).
What if It Happens: Not too much you can do as an individual to speed up the recovery, sad to say. Just keep your income coming in (as much as you are able to control that), pay down debt (and don’t add any more if you don’t require it), and build up an emergency fund in case the slow recovery leads to your own financial troubles. (And if (God forbid) you do happen to lose your job, check out my list of ways to bounce back from unemployment; it’s full of good advice.)
What if It Doesn’t Happen: If things recover much quicker than feared, it’ll be very good. However, there’s not much different to suggest in that case; keeping your finances in good shape is just as important even if things go well. The only difference is that hopefully you won’t be as worried about losing your jobs if the last traces of the recession are gone by this time next year.
That’s all there is to it; as I said in my title, I think you should hope for the best, but prepare for the worst.
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29
Jul
Posted in planning by Roger |
If you regularly add money to a 401(k), IRA, or bank account with the goal of withdrawing that money in the future, you need to able to calculate how much your money will be worth at the time of withdraw. If you made a single, one time contribution, it’s easy enough to calculate the future value by using the appropriate future value calculations. But what if you are adding money to the account; how can you determine how much your money will be worth when it is time to withdraw?
If you wanted, you could take each contribution and use the future value calculation to determine how much it will be worth when it is your time to use the money. However, that would be incredibly tricky to do, as well as requiring more time to do then we really want to expend (even setting up a spreadsheet could take hours). Luckily, there are ways to simplify the math; one (relatively) simple equation that allows us to combine all the future value calculations into one:
AV = C * [({1+i}^n - 1)/i]
Where AV is accumulated value, C is the contributions, i is the interest rate, and n is the number of periods (usually years, if i is expressed as annual interest). Crunch the numbers and you can determine how your contributions will add up over time. Of course, even with this formula, there’s still a lot of number crunching that you might need to do in order to calculate the future value. If you don’t want to go to all that trouble, I made up a shortcut table to make things easier on you:
This table shows the growth of annual contributions at fixed interest rates. Take the number of years you want to stay invested, go down to the expected interest rate, and you’ll have the multiplier you need. For a retirement in forty years and a 10% growth rate, for example, you have a growth factor of 442.6; if you invest $5000 a year, you’ll end up with $2.2 million when you retire.
Putting it all together
How can we use this equation to help plan our retirement goals? Well, let’s consider someone who is thirty years old, makes $50,000 a year, and has no debt or retirement savings yet. She decides that she wants to retire with $50,000 a year during retirement (adjusted for inflation) and hopes to retire in thirty years. She wants to invest fairly agressively for twenty years (at about 10% return) and then dial back her risk for the ten years before retirement (so she’ll only earn 7% return). She figures she can easily invest $5000 a year without decreasing her standard of living. How can she determine if she’ll meet her goals?
First, if she uses a safe withdraw rate of 4% of her final portfolio, she should have twenty-five times her desired annual income in her nest egg when she retires, a total of $1.25 million. Of course, given inflation, the actual amount needed will be much higher; we can use the future value calculation to determine how much money we’ll need in thirty years to be the equivalent of 1.25 million. We can’t know for certain how much inflation we’ll experience during this time period, so we’ll choose a reasonable but high value (like 5%) to stay conservative:
Future Value = Present Value * (1 + inflation rate)^number of years = $1.25 million*(1+0.05)^30 = $5.4 million
So, we figure on a total of $5.4 million for our example woman to retire. Quite an obstacle, but we have the power of compound interest on our side. If look at our table, we see that the intersection of twenty years and 10% interest gives us a factor of 57.3. With our given contributions of $5000, at the end of the first stage of her investment plan, she’ll have:
Accumulated Value = Contribution * Our Regular Contribution Factor = $5000 * 57.3 = $286,500
Not a bad start, but she needs more than that if she hopes to meet her goals. For the second part of her retirement plan, she’ll need to calculate her added contributions separately from the money she’s already accumulated. For the $286,500 she already has saved, the future value calculation at seven percent interest for ten years yields:
FV= PV*(1+i)^n = $286,500*(1+0.07)^10 = $563,600
And her new contributions, $5000 a year for ten years at 7% yield (for a factor of 13.8):
AV = C*Accumulation Factor (AF) = $5000*13.8 = $69,000
For a total of $632,600, well below the $5.4 million she needs to meet her goals. Now, she could try to run the calculations again, changing some of the assumptions that she made the first time around, with the hopes that by shifting things around a bit, she can increase her nest egg and decrease how much she’ll need. If she feels she can get by on only 80% of her salary, she can cut the amount she needs to $1 million in present value. Further, if she assumes that inflation is only at the average rate (about 3%)between now and when she retires, the amount of her desired nest egg will decrease (although, if she is incorrect in her estimates, she can find herself short when retiring). By delaying her retirement for ten years, she can give herself more time to build up her funds; she can also give her money more time to compound by investing aggressively for thirty years and conservatively for ten. Finally, if she stretches her budget and invests $10,000 per year, she can increase the power of compounding that will work for her.
Her new desired nest egg:
FV = PV*(1+i)^n = $1 million * (1 + 0.035)^40 = $3.26 million
How her contributions grow over the first thirty years (on our table, thirty years and 10% returns lead to a factor of 164.5):
AV = C*AF = $10,000 * 164.5 = $1.65 million
For the last ten years, this amount of money will grow as follows:
FV = PV*(1+i)^n = $1.65 million*(1+0.07)^10 = $3.25 million
Along with her continued contributions (ten years at seven percent interest gives a factor of 13.8):
AV = C*factor = $10,000*13.8 = $138,000
For a grand total of $3.39 million, more than she estimates she needs (which somewhat makes up for the less strict numbers she used in her initial calculations). This example shows not only how to run these calculations, but also how a few changes can shift the amount of money you expect to have at retirement significantly.
So, now that you know how to calculate the future value of your regular contributions, how many of you still feel your retirement plans are on track to meet your needs?
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