Archives for retirement category
28
Nov
Posted in Mixed Bag Monday, retirement by Roger, the Amateur Financier |
There are many financial goals you might have, from saving money for your children’s education to upgrading your home. But there’s one goal that stands above all others for most of us: retirement. Yes, the time when we can say goodbye to work forever is one of the biggest goals that most of us have nowadays. It’s also increasingly a personal responsibility, with all the individual retirement accounts and 401(k) plans.
With this emphasis on individual savings to reach retirement, it is more important than ever before to know what sort of preparations you need to make. Otherwise, you’ll end up delaying when you are able to retire (if you are able to retire at all, that is), and who wants that?
Q: How Much Money Do I Need To Retire?
A: That’s a tricky one; depending on what you wish you do in your retirement, you’ll need different amounts of money. There’s no hard and fast rule, but try this to get a planning number. Take your ideal yearly spending level, increase for inflation (double the value for every fifteen years until retirement as a conservative estimate), and then multiply by 25 (as 4% is considered a safe withdraw amount). You can also take advantage of the assorted retirement calculators available, to get a general idea of your needed savings.
'Enough money to swim in like Scrooge McDuck' is a decent, if somewhat vague, goal.
Q: What Investments Should I Use to Build Up My Retirement Accounts?
A: You’re going to want investments that have a high growth potential; stocks and stock mutual funds should form the bulk of your portfolio. They give you the possibility of building up your net worth at the quickest rate, allowing you to gain a higher net worth and hopefully retiring earlier. (You should also consider options like REITs to broaden your portfolio.) Now, this doesn’t mean you should have all of your money in stocks, particularly as you get closer to retirement; you should try to build up safer investments as you get closer to retirement. But that’s another question…
Q: How Do I Keep My Retirement Money Safe?
A: While stocks are useful in building your retirement funds, they do present the possibility of losing that money quickly in a downturn. You don’t want all your retirement money in stocks, particularly when you start approaching retirement; you want to move part of your savings into bonds and cash equivalents. There are numerous theories of how to divide this money, but my advice is to keep money you will need in the next 2 years in cash, for the next 3-8 years in bonds or similar investments, and for beyond that in stocks or other growth investments.
Q: Where is the Best Place to Retire?
A: Another tricky one; it depends on what you consider to be the ‘best’. Do you want to be closer to your extended family, or even further away? (I can sympathisize.) Do you want to party all night or relax all day? Do you want to see the world, expand your knowledge, start a new career (alright, this isn’t technically retiring) or simply relax? Your answer to these questions (and numerous others) will determine the best place for YOU, personally, to retire, which might not be the best for someone else in different shoes. (Although, there are more than a few suggestions out there.)
Q: When Can I Retire?
A: It’s difficult to put a timeline on that, with the numerous factors involved. The biggest one is your own level of retirement savings; once you reach the point where you can (safely) take enough from your savings to cover your spending, you can choose to work or not work as you see fit. Beyond that, you want to consider things like pension eligibility (if you are lucky enough to have that option), vested company matches, and Social Security payments for my US readers. The more you save, though, the faster you can call it a career and start the retirement fun.
I know that’s barely scratching the surface of retirement issues, a subject that fills hundreds of books and dozens of magazines. But hopefully this provided those of you are the absolute start of your retirement planning adventure with a few tips to get you looking in the right direction. Good luck!
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14
Mar
Posted in retirement by Roger, the Amateur Financier |
One of the goals that almost everyone working shares is a desire to eventually stop working; there are very few people who want to keep up their jobs for the rest of their life. (There are some exceptions, of course; Hugh Hefner being one that instantly comes to mind.) Retirement is the endgame plan of most working people, the final goal toward which we’re all working.
But, retirement itself is a relatively new concept. As I’ve noted before when discussing Social Security, the modern US concept of retirement has only been around for a little over a generation. The ‘three-legged stool’ model of retirement based on Social Security, pensions, and personal savings has been around only as long as Social Security itself, less than eighty years (a long enough time that most people currently alive cannot remember a time when Social Security wasn’t available, but in the grand scheme of history, barely a blip).
Ah, that's the life...the retired life
Retirement is currently changing even more. Pensions are rapidly disappearing to be replaced with saving plans like 401(k)s, Social Security is less and less prominent in people’s retirement planning (particularly among younger people), and the very idea that people should wait until sixty to enjoy retirement seems to be debated more and more. So, the million dollar question then becomes: what does the future hold for retirement?
Current Retirement Trends
As any good futurist knows, if you’re trying to figure out where something is headed, you need to look at what is happening to it now, and try to extrapolate out further in time to a logical conclusion. So, what’s happening with retirement now that will influence the concept of retirement in the future?
1) People are living longer…: There’s nothing wrong with people being longer lived; being a person myself, I hope to keep on living as long as possible (and then maybe a little bit longer). But it does mean some issues for retirement; the concept of retirement arose to allow those who were near the end of their life a few years of rest before, well, their eternal rest. Longer lifespans have caused issues in everything from Social Security to company pensions. While we’re on the subject of people at the end of life…
2)…And they’re healthier and more active, too: Again, I’m not saying that it’s a bad thing that most people aren’t working 12 hour shifts, six days a week, doing backbreaking labor anymore (at least, in the Western world). But, it’s leading to shift in how retirement is viewed: from a peaceful, restful time right before the end of your life to the biggest party you’ve ever had. Nowadays, retirement is seen as less of a slow march to the grave and more a time to enjoy everything you’ve built for the past several decades.
3) Increasing reliance on personal savings: Quick, if you are under forty, name a friend your age who is going to get a pension and who is not a police officer, school teacher, or other public worker. If you’re like me, most likely you drew a blank while trying to come up with someone. In the past several decades, there’s been an increasing push towards personal retirement accounts (401(k) plans and their brethren) and away from defined benefit plans. This trend is only going to continue in the future.
4) Less steady employment: With very few exceptions, the idea of going to work for a company after college (to say nothing of high school), staying with that company for forty to fifty years, and eventually retiring with a gold watch, a nice send off dinner, and a pension is all but laughable now. With the average person holding multiple jobs throughout their lifetime (on average, eleven jobs between the ages of 18 and 44), there’s a fair to good chance that you will not hold the same job through out your entire lifetime.
What the Future Holds
With all of these trends affecting retirement in mind, what do I think that retirement will look like over the coming decades? Well, here are a few thoughts based on my own experiences and insights:
-(Many) More People Working Longer in Life…: The sad but true fact of the matter is that most people aren’t taking the proper steps to save and invest enough to cover their retirement needs. In spite of the cajoling from myself and other personal finance authors, TV hosts, and other commentators, many people, even people young enough to have known about this new retirement deal when they first entered the working world, aren’t saving enough for retirement. The good news is that, thanks to being healthier longer, they can spend more time working to shore up their retirement funds. The bad new is that they’ll have to spend more time working in order to shore up their retirement funds. On the other hand…
-…And More People Will Retire Early: Let’s be honest, there’s nothing magic about your sixties that makes retiring during that time period ideal. As people get used to the idea that they can retire whenever they have enough money to sustain themselves (ideally on the interest and other proceeds from the investments they choose to put their money towards, not the invested money itself), you can bet that there will be diligent savers retiring years, if not decades, before they need to do so. Expect to see more fifty years announcing their retirements, as well as more than a few forty somethings. If that weren’t enough to help diversify the crowd around the retirement center pool…
-Expect More Mini-Retirements and Longer Breaks Between Jobs: With so many people switching jobs so often, it’s inevitable that there will be breaks between their periods of employments. One reason most people try to keep those breaks as short and infrequent as possible is fear that such breaks will appear less desirable to would-be employers; but with people spending longer and longer periods unemployed through no fault of their own, I foresee a time when employers are more concerned with how you spent your time, rather than how much time you had. I think we’ll see a rise in ‘mini-retirement‘ type vacations, from people looking to take a break from the workaday world, as well as more people using breaks in their employment for further education and possible career changes (much as I’m doing, going back to school for a higher degree).
-The End of Retirement, Period: No, I’m not predicting a dark day right around the corner where corporations stop allowing people to retire, forcing them to work right up to the moment they die. (Although, that could make a good horror movie concept…) Rather, what I’m talking about is a complete rethinking of the idea that there should come a point where you stop doing productive work in society, while you are still able to do so. I foresee that before too long, ‘retiring’ from your profession is seen as the perfect opportunity to do what you want in life, most likely starting a new job or creating other work for yourself. You already see this with the most productive retirees; why shouldn’t the idea continue to spread?
That’s my idea on the future of retirement; what’s yours? How will the typical retirement in 2061 differ from that in 2011? (Besides the fact that mostly robots will be retiring in 2061, of course.) What other factors do you see making a big difference in how retirement will look in the future?
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28
Dec
Posted in retirement by Roger, the Amateur Financier |
One of the most basic tenets when you are saving for retirement is to dollar cost average your investments by contributing the same amount of money each month (or quarterly or weekly, depending on your preferred investment schedule). By doing so, you’ll end up purchasing more shares of the (usually) mutual funds when the price is lower, and fewer when the price is high. The end result is that you end up purchasing more shares at a lower average cost, than by purchasing the same number of shares each month. For an example, let’s check out the following table:
Dollar Cost Averaging in Action
If you wanted to invest $100 in the Vanguard 500 index fund (the first and probably most popular index fund) on the fifteenth of each month (or the last business day before the fifteenth, for months when the fifteenth falls on a weekend or other holiday), this shows you an example of how dollar cost averaging will lower your expenses. If you take a straight average of the share price, you come up with a share price average of $87.56.
But, you didn’t purchase the same number of shares each month, did you? Nope, because you put in the same amount of money each month, you ended up buying a total of 13.913 shares; dividing the total you spent ($1200) by this number of shares, and you’ll see that you bought your shares for an average price of $86.25. Because of your dollar cost averaging, your per share cost is a bit lower than the average share cost of the year. If you’re in the process of buying sharing to build up your investments, this is a good thing; more shares for less money!
But let’s reverse the money flow; imagine you’re a retiree who is selling your investments in order to generate additional funds in retirement. Now, you are selling enough shares of your Vanguard 500 index fund to generate $100 each month. You’ll have to sell more shares when the price is low, and fewer when the price is high. The end result is that you’ll get less money for selling more shares; not the sort of situation in which you want to find yourself.
This is known as negative dollar cost averaging (DCA); where the process of dollar cost averaging, when thrown into reverse, ends up increasing the number of shares you need to sell in order to keep your cash flow the same. (It was mentioned as part of Yes, You Can Still Retire Comfortably!, which recommended a version of market timing to counter the problem.) How can you prevent negative DCA from taking its toll on your investments? There are a few possible methods:
1) Sell a constant number of shares: Negative DCA results when you sell different numbers of shares at different prices in order to generate constant cash flow. You can break up this problem by selling a constant number of shares instead. If you sell one share each month (for our example), you know that by the end of the year, you’ll have sold 12 shares, regardless of the changing share price over the year. The problem is, you’ll have to accept a fluctuating income stream from your sales; if the share prices drop in half, your income from selling these shares drops in half, as well.
2) Rebalance your portfolio regularly: Assuming you have more than one type of investment in your portfolio (and you should, unless you have a target-date fund, which will rebalance automatically), you should make an effort to rebalance your portfolio on a regular basis. (At least yearly, although quarterly or even monthly rebalancing can work provided you are working in a retirement account and don’t have to worry about taxable events when buying and selling mutual funds.)
When you rebalance, you sell the portion of your portfolio that has risen above your desired allocation and use the proceeds to buy the under-performing funds. You’ll be putting the ‘buy low, sell high’ formula back to work for you, and won’t have to worry about negative DCA working against your progress. Alternatively, you could…
3) Sell from the best performing funds: A poor (or tax-adverse) man’s version of rebalancing, you can sell from the funds that are performing the best (the ones that represent a larger portion of your portfolio than you originally intended). The result is that you’ll bring your portfolio more into line with your desired portfolio, and you’ll avoid having quite so many taxable events (since you won’t be selling large portions of your portfolio to shift them around at once). While not completely relieving the need for occasionally rebalancing your portfolio when things get really off kilter, it’s not a bad way to generate needed funds without causing any negative DCA problems.
Hopefully, you now have a better idea about negative DCA, and what it will do when you start to draw down your retirement income.
Has anyone else given any thought to negative dollar cost averaging (or dollar cost averaging in general, for that matter)? Are there any other methods of avoiding negative dollar cost averaging that I missed? Aren’t mathematics just a load of fun?
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24
Aug
Posted in retirement by Roger, the Amateur Financier |
I’ve been thinking lately about cashing out lately. For those of you who’ve never heard the term, the concept is basically to build up your money so that you are able to effectively retire early, usually in your forties to fifties, and do whatever you want with your new found free time. Depending on your personality, that might be taking on new hobbies, expanding the time you devote to your existing hobbies, simply spend more time with your family, or even start working a job you really enjoy, regardless of the pay rate.
So far, cashing out sounds pretty good; what could be better than calling it quits on your job a decade or two ahead of schedule and being able to live every day like it was a vacation? Well, unfortunately, there are some downsides: because you’re trying to retire so early, you’re pretty much going to be on your own as far as saving for retirement. Retiring before the age of 62 means you aren’t entitled to even partial Social Security benefits, and pensions (for those lucky few who still work at companies that have them) are likely going to unavailable to someone who’s only been on the job for fifteen or twenty years.
“No problem,” you say, “I’ll just depend on my own retirement savings to carry me through.” Well, that’s fine, except early retirement means you’re not giving your best friend as an investor, compound interest, much time to work. This means, if you want to get to the amount of money you need in a much shorter time frame, you need to add much more money to your investments. How much more? Well, let’s say that you crunch some numbers and decide that taking out $40,000 of your money each year will allow you to enjoy your early retirement. If we assume this amount will represent no more than 4% of your total portfolio, that means you need one million dollars in your account on the day you retire in order to make your whole plan work. If you’re saving for 40 years, no problem; according to my ‘back of the napkin’ calculations, an annual contribution of $2100 more than gets you to your goal. (We’re setting aside inflation at the moment, to make the calculations a bit easier; don’t worry, we’ll cover how inflation affects the amount you need to invest soon.)
The problem starts if you try to cut down that amount of time until retirement. If you want to retire in 30 years, expect to contribute $5600 a year to reach one million; more than twice as much, but still a workable amount for someone who requires about $40,000 a year to meet their needs. To retire in twenty years, you’re looking at a contribution of about $16,000 a year, nearly tripling your savings requirement. Finally, to reach a one million dollar nest egg in ten years, you will need to contribute $58,000 a year, nearly fifty percent more than you intend to spend each year in retirement. If you are not making a six figure salary, you’re going to be hard pressed to come up with nearly sixty grand year; and if you are making that much, are you really going to be satisfied only spending forty thousand dollars each year after you retire?
If that hasn’t shattered your dream about retiring to a tropical paradise in just a few more years, let’s note that this is an oversimplification. For one thing, we haven’t talked about inflation at all. This is one area where the early retirees have a bit of an edge; less time until retirement means less time for inflation to eat away at the real value of your money. Unfortunately, it also means you’re have to increase the figures we just gave for the yearly contributions; even ten years from now, a million dollars just won’t be worth as much. To get an inflation-adjusted million after forty years (with a 3.5% assumed rate of inflation), you’ll have to increase your yearly contribution four-fold, to $8400 dollars; in order to retire in ten years with an adjusted million, you’ll need to put in $82,000, a nearly ten-fold increase in your contribution amount from a forty year horizon.
After hearing all this, are you sad, depressed, and ready to just give up on your dreams of early retirement? No? Good; if you realize the enormity of the task ahead of you and still are determined to retire early, you might just have the resolve and determination in order to make your dream come true. To help you out, let’s end this column on a higher note and go over a few steps for anyone who shares my dream of leaving the rat race and retiring early:
1) Plan carefully, and conservatively - Your first step should be to sit down, crunch some numbers, and see (a) where you currently are, financially, (b) where you hope to be when you retire, and (c) what path you need to travel to get from (a) to (b). Decide just how much you will need when you retire (adjusted for inflation), the amount to invest each year, and whether it will be possible for you to pull that much from your budget to add to your future plans. If it’s simply not mathematically possible to retire at the time you want (without working two more jobs or simply never eating), try to shift your desired retirement date a bit; aiming to retire in twenty years rather than ten cuts the (inflation-adjusted) amount you need to save down more than fifty percent (to $32,000, if you are curious), and going from a twenty to thirty year time frame (which could still lead to retirement before the AARP decides to add you to their ranks) cuts the needed amount in half again (to $16,000). Of course, all these figures assume you’re shooting for an inflation adjusted one million dollars at retirement; you’ll have to adjust them to meet you own particular situation.
2) Cut down on your spending – There are two advantages to this course of action. First, if you’re spending less each month, you have more money to put towards your early retirement, making it easier for you to meet your investment goal. Second, if you find you’re able to live a good, full life spending only thirty thousand a year rather than forty thousand, you can probably adjust your final goal downward, requiring less in contributions (or netting a quicker time to reach the needed amount with the same contributions).
3) Invest More – If you’re trying to retire years, if not decades, ahead of the rest of your office mates, you can’t invest the same amount that they do. Putting 10% of your paycheck into a 401(k) every year might (and I stress, MIGHT) provide you with enough of a return in order to retire at 65, but it won’t be enough to give you a ‘Get of Work…Forever’ card by the time you turn 50, to say nothing of when you’re even younger. Shoot for 20-30% of your gross income, and try to ramp it up a bit more, if possible.
You should also look carefully at the rules governing retirement plans, to determine if, should you invest in a 401(k), IRA, or Roth, whether you will be able to get the money out when you need it and how much it will cost you in penalties and other fees when you do. If they look like they will benefit you, feel free to take advantage of their tax advantaged nature for a portion of your retirement savings; if not, simply use taxable accounts. (A complete guide to all the subtleties of retirement accounts as they pertain to early retirees is bit more than we’re going for right now; just be aware that usually, taxable accounts will be better when you’re trying to retire early, but not always.)
And most importantly…
4) Make sure to have fun along the way – It might be tempting to take every spare cent you have and put it into your retirement savings (and you might argue that I just told you to do as much in my last point), but if you do so at the cost of your current enjoyment, you’re going to spend some of the best years of your life doing an impression of Scrooge while your friends, coworkers and classmates are having the times of their lives. Furthermore, if you spend the first twenty years of your adult life depriving yourself, you’re going to be that much more likely to live it up when you do retire, and possibly blow through all the money you worked to accumulate. Neither of these events is something I want to happen to you.
A much better strategy is to be conscious of your financial goals and how much you are trying to save, but not to let it stop you from having a life. Go on, attend parties, go on dates, spoil your significant other every now and then, and perhaps even spoil yourself occasionally. Just try not to go over the top when you do so; be frugal in your day to day life as well as your celebrations, and you can have your fun AND save your desired amount for an early retirement.
Here’s looking at good luck to you in your attempt to retire early; I hope I’ll have the chance to join you!
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