Best Laid Plans

Posted on April 2, 2020 by wiseguide

Everyone has a plan until they get punched in the mouth
–Mike Tyson

As I write this the world is in lock-down due to the spread of a global virus. I write mostly about financial issues but try to consistently keep the perspective that your time is really your most valuable resource, and your continued health is what enables you to make the most of that time. So, remember that if you and your loved ones are relatively safe from this, consider yourself among the fortunate. My friends and family who are doctors and nurses see it up close and personal, and I don’t know any of them who have their stock portfolio as one of their top 10 worries. Just keep that perspective.

With that as an important backdrop, looking at this as merely a financial impact can be jarring. I’ve talked about this in prior posts, the occasional, even significant decline in the stock market is completely expected, and is actually a positive. One of the other positive things to result from a downturn is it gets you to measure your real response to a crisis. I can ask myself, what would I do right now if this were happening and I was already retired with my 50/50 stock/bond portfolio? If I’m being honest with myself, I’d be freaking out. This is extremely valuable insight into my psyche, and allows me to avoid those freak-out moments as an old man, at least when it comes to money.

I still think the 50/50 portfolio can work for many people, but recall my analysis for that example showed there was a 10% chance of outliving your money using the 4% rule for withdrawals. As risk-adverse as I am, I realize for me, that’s too big of a chance. I also realized that to mitigate the impact of this kind of downturn in the future, I’d want to have a plan that required no stock sales, so as things dropped it wouldn’t really cause any short term panic selling, which as a stock investor is what you have to avoid.

Here’s the difficulty. At today’s interest rates and stock dividend yields, you can’t count on 4% yields. You can’t really even count on 3%. To get to 4% in today’s environment you have to be reliant on some gains of your investments, or be willing to dip into principal–which can be a vicious cycle of reducing your investment assets, which leads to less yield, which causes you to withdraw more principal. I’ve adjusted my plan to try to address this.

In earlier posts, I talked about two buckets of funds, one to sustain your life from age 59.5 using designated retirement funds, and another to get you from whenever you stop working to age 59.5, your “bridge” to retirement. I’m still a believer in the long term value of stocks, so still recommend my asset allocation for those long term assets. I may rethink the retirement age allocation, but I’m sticking with it for now. For the shorter term assets, part of my solution is an asset I’ve tried to avoid up until now, rental real estate. I’ve avoided this not because I think it’s a bad investment, but because unlike other assets classes, it requires work, so to call it passive income is a stretch. It’s a little bit investment, a little bit part time job. But I’ve come to realize this is my favorite income-producing risk-adjusted asset right now. I’ll have a follow up post on this, but I’ve dipped my toe in, I can’t stay out any longer.

For shorter term, bridge assets, I recommend the following. Instead of my prior approach which was to determine the earliest possible date you can retire, take a little more conservative approach and lay out your intended work plan. How long do you believe you’ll work full time? Part time? With that plan, you can estimate each year’s income and with your forward-looking budget you can estimate expenses. You can do this for each year going out to age 59.5, I even try to estimate when I will make major purchases, like cars.

With your short term assets you can also estimate both yield (income produced) of those assets and growth of those assets. The following is a reasonable example, you may want to adjust these based on interest rates, market conditions, etc. Note the yield and growth values for Real Estate vary considerably depending on how much you initially invest. If you buy the property outright, more yield, less growth. If you finance a great deal of it, less yield, more growth.

Asset	Yield	Growth
Stocks	2%	5%
Bonds	3%	0%
Cash	2%	0%
Real Estate	3%	3%

For each year, assume the yield of your investments can be used to supplement your income and add that to any money you expect to earn working. If your expenses exceeds your income (from investments and salary) draw money only from cash and bonds (the ratio of this draw can be varied but one approach is 50/50). If your income exceeds expenses, put the extra into cash and bonds. A reasonable place to start is equal 25% allocation in each of the asset classes above then project out your balances for each of these assets classes for every year until you are 59.5 or whenever is your long-term retirement age. Do you finish with positive cash and bond balances? If yes, then you have a plan to get to 59.5 without needing to sell any stocks or real estate holdings, so when the market tanks again (remember these downturns are nearly guaranteed, the difficulty is predicting when they will happen, not if they will happen), you are positioned to continue to live your lifestyle pretty much as planned. The idea is trying to set up a condition where a down stock market or down real estate market has no significant bearing on your life.

Why keep any money in stocks at all? Well, you could argue that the risk isn’t worth it, but I still believe that you should have exposure to the growth power of stocks. Over the long term this should still finish as your most productive asset.

What if that plan doesn’t work? What if it shows you run out of cash? Make adjustments. Maybe you have too much money in stocks or real estate. Maybe your date to quit working is too early and needs to be pushed back. Keep adjusting until you have a plan that shows positive numbers for all your assets.

Finally, remember that history says fortunes are made during market downturns. Warren Buffett’s famous financial advice to be “fearful when others are greedy, and be greedy when others are fearful” is difficult to execute. However, hopefully this provides you the confidence that investing in stocks for your long term assets is still a good idea, if buying prior to the crash made sense, certainly buying after the crash makes even more sense. These purchases do not care about the price of stocks tomorrow or next week or next year. These purchases are made looking out 10-20-30 years, where if history is a guide, stocks will be a smart purchase.

Gain or Pain

Posted on April 20, 2019 by wiseguide

For many people, any time they are deciding on a big ticket item like a vacation or some luxury item, the calculation simply comes down to “Can I afford the monthly payments?” A little better question is “Have we saved up enough money?”, but I’d argue even this is the wrong approach when making a decision.

I don’t want to tell anyone where they should or shouldn’t spend their money. OK, I sometimes do, but really that is an individual decision based on what every person values, and everyone needs to make that decision for themselves. However, I think everyone needs to have the right information when making purchasing decisions, and that comes down to my common theme of using time, not money, as your limited resource.

Instead of asking “Can I afford the payments for that dream vacation?” or even “Do I have the $10,000 in my account for it?” a better question to ask is “How much longer will I need to work to offset this purchase?”. Instead of paying in dollars, you are really paying in “Pain Dollars” or working time. This is key, because the conversion of dollars to Pain Dollars is different for everyone. For example, let’s say that vacation meant you’d have to work 4 more months (more on this calculation in a moment) at your job. Is that worth it? For some, yes, the reward is worth the pain, and for some no. It depends on how painful your job is and how much you value the item you are about to purchase.

To figure out what your Pain Dollars conversion is, I use my early retirement “Crossing the Streams” approach, and compare my original asset curves with one set back by the purchase of the item ($10,000 in the case of this vacation). I suggest you read this blog post to understand this a little better if you haven’t already.

Looking back at that original scenario, we had a 32 year-old doing well, with a projected early retirement in March 2043 (age 56). What if she decides to take that vacation? Her current bucket one assets decrease by $10k and her crossover point shifts by 4 months:

I know what you’re thinking, if I make more than $10K in 4 months, how can the impact be this great? And, the impact above looks like a lot more than $10k! The answer is a) not all of your money you make goes to savings (in fact most doesn’t) and b) we are looking at the impact of a purchase today compounded over time. Is that dream vacation worth it? Some would say yes, some would say no, but I think everyone should be informed of its impact in his or her working time.

This is also part of the power of working in a job you really enjoy. For those lucky enough to love their job, the conversion rate of Dollars to Pain is very advantageous, meaning your able to exchange very little pain for a great deal of dollars. By thinking about “paying in Pain” everything just became cheaper! Four months for you might be pennies—doing your job everyday is a pleasure—four months to someone else might be a fortune.

Punching Out Early Part II: Crossing the Streams

Posted on March 31, 2019 by wiseguide

When I was a kid, I went to see the original GhostBusters in the movie theater. Looking back, it’s a combination utterly ridiculous and great movie. One thing you learned is never cross the streams:

“Try to imagine all life as you know it stopping instantaneously and every molecule in your body exploding at the speed of light.”
–Dr. Egon Spangler
“That’s bad. Okay. Alright, important safety tip, thanks Egon.”
–Dr. Peter Venkman

Here, we’re going to talk about crossing the streams, and much like the ultimate destruction of Gozer the Destructor (another geeky Ghostbusters reference), it’s good. In the last post we created curves for how much we might need to punch out of our jobs, and have enough to support our chosen lifestyle. Now for the fun part, figuring out when we can get there. We’ll look back at Bucket 1 first, life up to age 59.5.

Bucket 1. Again, this consists of three parts:

Home Equity. This is the current value of your home (you can use zillow if you need an estimate) less your current mortgage. This will go up every year as you pay down the principal on your mortgage. Since we did not adjust our retirement home for inflation, do not adjust your home value either.
College Savings. Hopefully in a 529 savings plan where it earns returns tax-free
Regular Savings. All of your other accounts that are not specific retirement accounts (401k and IRAs are not part of this bucket)

We can project each of these out with time based on the amortization schedule of our mortgage, and an assumed rate of return of the college and other savings accounts. We then add them all together, this might look like the following:

Bucket 2 is addressed in a similar way, and includes 401k, IRA or other retirement only assets, yielding a rate of return appropriate for your asset allocation.

Once we have an idea of our asset growth with time, we can compare that to the needs curves and look at where we cross the streams:

In order to retire, we need to be above both curves. For this example, the most restrictive case is our Bucket 1 money, and indicates an expected early retirement at age 56. This is not guaranteed, in fact there is a LOT that will happen between age 32 and 56 that will change both curves as you get older and life happens. Also, we had to make reasonable guesses for things like rate of return of our investments. But I find this a really useful exercise to compare my current and future lifestyle choices with my current and future savings to see where these choices project. Don’t like the answer? Save more! Or learn to be happy with less in the future! Conversely, maybe the curves are showing a projected retirement well before when you’d like to stop working, possibly indicating that you are not living it up enough in your present. That is sub-optimal use of your assets allocated to your time also–but note, almost no one falls into this group. (Oh no, too much money! Gah!)

Punching Out Early: Part I: What do I need?

Posted on March 17, 2019 by wiseguide

I’ve had some earlier posts on figuring out when you’ll be able to retire, taking the traditional route to 65. However, for many people, myself included, that seems like an awfully long time to spend doing something that isn’t first on your wish list when you get up in the morning. If your job does fit this category, fantastic, and the wish to retire early isn’t nearly as strong. But for most people, they’d really rather do something else, which is the allure of early retirement. People in the FIRE movement endorse the idea of retiring at 30 or even sooner! While I think much of this message gets confused and oversold, early retirement is a laudable and achievable goal. Let’s look at a strategy.

One magic number is 59.5. That’s the earliest you can start drawing on tax-deferred 401k and IRA savings. So, it makes sense to break up your assets into two buckets, 1) Money in taxable accounts for retirement life before 59.5–assuming a goal to retire before this age–and 2) Money for life after 59.5 (in tax advantaged accounts). Think of the first bucket as a bridge account since it bridges your retirement date to 59.5 when your true retirement assets become available. For simplicity, I assume Bucket 1 has to contain everything to get me started in retirement, meaning it covers my retirement (preferably without a mortgage), my kids college, and the money I need to live on until Bucket 2 kicks in at 59.5.

Bucket 1. Similarly to the earlier post on retirement, we first need figure out how much we need. This is a curve that represents our needs starting in the present (Retire Today!) and extends into the future, and is the sum of 3 elements:

Retirement Home Cost. You can use today’s dollars if you are a current home owner since later in the calculation you’ll be offsetting this with your current home equity in today’s dollars. If you don’t currently own a home, you’ll have to calculate this using today’s dollars and inflation, I suggest 2.5%. If you want to rent in retirement, this number is zero, but remember you’ll have to figure the rent into your needed monthly income
College Funds Needed. My earlier post had a rough calculation you can use for each of your kids, assuming you want to pay their way through school.
Living costs, from now until 59.5. If retiring after 59.5, this is zero, but otherwise is a little more tricky than the other two. You’ll want to devise a retirement budget to your desired lifestyle, similar to the approach we took earlier. But remember, early retirement means you’ll be paying your own medical insurance without Medicare, not a low cost item. Also, I suggest tweaking this number up based on inflation to the rough date where you think you’ll actually retire. There are a number of ways to calculate the lump sum you need to support this budget, you can simply multiply your budget by 25 (the 4% rule we used earlier, assuming living off interest only) but that is probably a little too conservative for this bucket, knowing you have another bucket behind it. I use the Present Value equation in Excel, so my needs decrease with each year I get closer to 59.5. In total, your Bucket 1 curve will look something like this:

You can always play with the assumptions, but the curve in general gets lower as you age, simply because the time is decreasing from now until age 59.5, so you need less money to live.

Bucket 2. Bucket 2 is simpler, it only takes into account what you need live on, from age 59.5 until….whenever. Here I’m going back to the conservative rule of 4% withdrawal and assuming I have to live off the interest only. This is conservative, but if I don’t adjust my yearly budget for inflation, it kind of balances out. You can also use the Present Value approach used above in Bucket 1. The question we need to ask is how much do we need as a lump sum for any given year of retirement, such that the money will grow to the minimum amount we need at age 59.5? This is the amount saved at any moment in time that we assume will grow to our need at age 59.5 without the need for further contributions (which we aren’t making when retired!). This will increase each year, since each year there are fewer years to age 59.5 (and thus less time) for our money to grow. The bucket 2 curve will look something like this, this assumed an 8% return on assets:

When can you retire? If your Bucket 1 assets are above the needs line and Bucket 2 assets are above the needs line, you are in-line for retirement. (Ha! See what I did there? Graphing humor. Always kills).

But wait, those are some pretty big numbers, you mean if I want to retire at 40 I need nearly $2M in Bucket 1 and half a mil in Bucket 2? For the scenario above, yes, per our assumptions, at least that much. Are the FIRE people accumulating millions by the time they’re 40? Well, no, probably not. The FIRE people are (hopefully) doing these same kinds of calculations and saying “Whoa, those are some pretty big numbers!” and altering their needs way down to get them more reasonable. Maybe their kiddos will go to community college, maybe they’ll live on $30K a year (though I really don’t know how that would work with health insurance), maybe a $100K condo will do just fine. You can do the same if you like, its all about what kind of lifestyle you value, and what kind of time you’re willing to put in for it. That’s different for everyone, but I do have some future advice on how to strike that balance. (FYI, to give you an idea of this impact, changing to the assumptions I just listed is a need of ~$500K in Bucket 1 and ~$200K in Bucket 2, still a big nugget, but a little more reasonable for age 40).

In my next post, we’ll look at where we stand and projecting out when we’ll meet both criteria.

Freedom, not Retirement

Posted on February 23, 2019 by wiseguide

mountain-984277_640 The Financially Independent, Retire Early (FIRE) movement has gained a decent following recently. Generally, I’m a fan, anything that is encouraging young people to live beneath their means and save as much as possible is right up my alley. Mr Money Mustache is probably the most popular among those promoting this effort, and I encourage you to check out his blog, there is a lot of practical advice to living a life of wealth. But like anything, the approach can be oversold as another magic pill of the easy path to wealth. Back to math for the answers. Love you, math. Love you.

Some within FIRE will shout Retire at 30! Sounds too good to be true, and generally it is if you take it literally. Recall the post on budgeting, the first thing you have to figure out is how much you’ll need to live, and remember if retired you are paying your own medical insurance now. Don’t be shocked but this can be $25-$30K per family (assuming no subsidies from the Government here) and rocketing up every year. And you HAVE to have health insurance. Remember, your time, and indirectly your health is the one thing you absolutely have to protect. You also have food, housing, bills, some minor entertainment. Don’t expect to give up Netflix and be able to live on $10 a day. Assuming all of these things, $60k per year (assuming that health insurance remember) is not an extravagant need. Recall the post on living in retirement, a general rule of thumb is assuming you can withdraw 4% each year for living expenses (conservatively assuming you aren’t drawing down the principal), you need $1.5M, and this is pretty bare bones living. Let’s assume you start working at 22, and you assume a solid return of 11% on your investments which is a pretty aggressive assumption. To retire at 30, you’d need to save roughly $125,000 per year to get to $1.5M. This is savings after tax. You can’t count your 401k or IRAs, those aren’t eligible for withdrawal until you’re 59.5 (question, Congress people. why the 0.5? seems so random). Do you have a job at 22 that allows you to live and save that much? No? Hmm, how about retire at 40? With the same assumptions, it’s still $30k per year. Every year, starting at 22, and assuming you get an 11% return every year. This is at least possible but still really, really tough for most people. Plus, remember that the 4% rule is no guarantee the money will last (see my post on Monte Carlo analysis).

So I’m not anti-FIRE movement, but clearly there is something else to this besides: Step 1, get a job making insane money. Step 2, spend almost none of it. Step 3, invest in a stock market that is consistently going up.

Instead, the movement really should be called “Free to Pursue Work Regardless of Earnings (FTPWROE)” but that doesn’t have quite the same ring to it, and the vowels are in terrible locations. Think about “retirement” at 30 or 40. This is not sitting on a beach with a Mai Tai. Instead, it is saving a decent cushion, so that you can pursue work you find more meaningful and enjoyable, regardless of the income. Recall my post on the 3 elements of a job, here you are ignoring the income element and strictly focusing on the time the job requires and your personal enjoyment, and there is a beauty to this that I respect. Suze Ormann famously criticized the FIRE movement but I’ll bet some of that is she has a certain picture in her head of retirement because she literally retired to a private island in the Bahamas. I understand she and her wife do insane amounts of fishing, and have to admit, sounds fantastic. But FIRE people are still looking to achieve something (besides landing a big snapper). So if you leave your accounting job and decide to be a youth counselor (maybe with an outfit that offers health insurance, score!), maybe you can do it with a big enough supplement nest egg.

So take the good parts of the FIRE philosophy: live frugally, save extensively, invest wisely. Seek joy in the free/inexpensive things instead being sucked into the materialism hole. The power of that pile of cash you build may not be enough to sink your toes permanently in the sand at 30, but may give you the cushion you need to live the life you want.

Why the 50%-50% ratio of stocks and bonds in retirement

Posted on January 26, 2019 by wiseguide

apple-926456_640 In an earlier post on asset allocation I talked about the notion of a 50/50 split of your assets between stocks and bonds at retirement. I also mentioned the “4% rule” for calculating withdrawals from your accounts in retirement as a good number. Where did these come from? It’s not simply a compromise between the assets, and we can show why it makes sense. With math! Hurray!

Previously I showed how we can use Monte Carlo analysis to predict probabilities of certain events, by running many possible future outcomes using prior years’ mean (average return) and standard deviation (variation of a given year’s performance from the mean). In the case of retirement, the goal is for the money to last for the rest of your life. Let’s assume you are taking good care of yourself and you are going to have a nice, long 30 year retirement. And because of inflation, you’re planning on increasing your withdrawals by 3% every year. We can run Monte Carlo analysis for different asset allocations to see what is the probability you will still have some money left after living off your nest egg for these 30 years. I did a simple analysis with only 100 cases just for illustration, most Monte Carlo analyses would use many more, but this should be reasonably close. Also, here I’ve assumed that stock and bond means and standard deviations will mimic those of the past. Again, not a guarantee. Here’s what I got:

Probability of your money lasting if 100% in stocks: 83%

Probability of your money lasting if 100% in bonds: 39%

Probability of your money lasting if 50/50: 90%

These results should look weird. So all stocks is pretty good, all bonds not so much, but if I allocate some of my stock money to these (worse performing) bonds my results get better? Huh? Yep. Remember your goal for this money: last 30 years. It is not maximize the most money I can possibly make, that would be in stocks. What happens is the addition of the lower variable bonds help smooth out those cases where stocks get hammered, and increase your chances that your money will last.

Is 50%/50% perfect? Not really. Here’s my analysis for more stock bond ratios, for convenience graphed as % of assets in bonds:

This analysis shows an ideal is actually about 60% bonds, but what’s clear here is you need the growth power of stocks to help your returns, but there isn’t a lot of difference between 40%/60% to 70%/30% (bonds/stocks) in terms of probability of the money lasting. I like to lean a little heavier toward stocks with bond yields so low lately, but I think anywhere in this range is fine in retirement. The other thing to notice is, how comfortable are you with a 10% chance your money will run out before 30 years? If not, the 4% rule might be more of a 3.5% rule. Or, as I mentioned earlier, you can throttle back your spending in the years of stock/bond downturns. Living to your means, always a good idea.

No guarantees in life, a quick lesson in probabilities

Posted on January 12, 2019 by wiseguide

cube-1655118_640 Don’t panic, I’m not going to get into too much math here. But it is very important to understand that all of personal finance is about making projections, which are far from certain. I will repeatedly emphasize that no one has a good crystal ball on exactly what the future holds, but we can use the past and a little probability to help us determine our chances. For example, would you retire if you had a 80% chance of outliving your assets? 50% chance? 10% chance? near zero? That answer is different for everyone, but no one can make that decision without getting an estimate of those probabilities, here is an approach you can use.

Although I don’t believe anyone can precisely tell you what will happen tomorrow or next month or next year, it is reasonable to look at stock and bond price histories for any given time period, going back 100 years if you want, to make estimates of the general trend of those assets. Let’s look at the past 10 years, the longer term numbers actually aren’t too different. The average return of the S&P 500 (which we’ll use as our metric for stocks) is 10.4%, with a standard deviation of 18.3. For the Vanguard Total Bond fund (which we’ll use as the metric for bonds) the average is 4.0% with a standard deviation of 2.8. Don’t worry if you skipped that lesson on standard deviation in math class, just understand that a big number relative to the average means that the return fluctuates a lot year to year, and a small number less so. We can then use something called Monte Carlo analysis which is a complicated term for a simple concept, run a whole bunch of sample “futures” and see how they all turn out. Think of it like throwing dice 1000s of times and recording what numbers you get. You can make some inferences on those future possibilities based on the results.

Using a little magic in Excel with random number generation for the return on a given year, and the means and standard deviations above, we can see what is the probability of getting to our retirement goal. Recall in an earlier post we showed we would get to our retirement savings goal of $1.2M. Hurray! Guaranteed? Uh, no. Crud. Going back to our 30 year old with $50k in her 401k, using our asset allocation, adjusting each year, and diligently saving, the chances of having at least $1.2M in the account at retirement? 78%. Good, but maybe you don’t want to bet your whole livelihood on it. Before getting completely bummed, the chance of at least $2.0M? 38%. Not bad, probability works both ways! Also, remember you aren’t doing this in the dark! If things happen to not be working out the way you planned, you can adjust. Maybe your house is a little smaller, or you work another year, or find cheaper hobbies; you have the ability to live to your means, no matter what the future holds.

If you are a weirdo like me and interested in the gory details of the excel calculations, here is a link. It’s really not that bad!

Asset Allocation

Posted on December 22, 2018 by wiseguide

chicken-1686641_640 Where you put your money to attempt to maximize your returns while protecting your money is the subject of countless studies and makes up the primary job of many financial professionals. My suggestion for asset allocation is far simpler than what many of these professionals would recommend, and due to ultra low fees, the returns are likely better.

The first questions that need to be answered for asset allocation is a) What is the money for? and b) How long until you need it? For definitive expenses (like your emergency fund or saving for a major purchase in the next year or two), the money should be in something safe, like a CD or a money market fund. For something like retirement or other longer-term investing, it’s more interesting. Here is a starting example:

Age 25, Planned Retirement Age 65: Years to Goal: 40 years

For anything 25+ years to the goal, my recommendation is a 90%/10% stock/bond ratio. This isn’t magic, but certainly with a long time horizon, history has shown the vast majority of your money should be in stocks. I prefer a diversified group of index funds of all sizes, both domestic and international. You could go a long way to achieving this with just two funds: 60% in Vanguard Total Stock Market Fund (VTSMX) and 30% in Vanguard Total International Fund (VGTSX), The other 10% of the money can go into bond funds, such as Vanguard Total Bond Fund (VBMFX) and Vanguard Total International Bond Fund (VTIBX). I’m a big fan of Vanguard for their low fees, but if your 401k does not offer these funds hopefully you can find some similar funds that have very low fees—less than 0.2% should be standard for an index fund. For God sakes hopefully the funds they offer have no loads (sales commission). Aside—this is completely wasted money. “Sales Loads” are money paid to the salesperson for “selling” you the fund. They are so worthless you likely didn’t even know they sold you anything. This is different from the higher fees that actively managed funds (vs index funds) charge, that money is actually for the person picking stocks for you, but isn’t worth it either.

The suggested allocation looks something like this

60% Vanguard Total Stock Market Index Fund
30% Vanguard Total International Index Fund
8% Vanguard Total Bond Market Index Fund
2% Vanguard Total International Bond Market Index Fund

The above can be substituted for other equivalent index funds, you are looking for funds with fees of <0.2%. This gives you a broadly diversified portfolio in just four funds.

Once you get within 25 years or so from your retirement age, you want your portfolio to start to get more conservative, meaning a shift from stocks to bonds, such that at retirement you have something close to 50%/50% split of stock and bonds. I’ll have a future post on the logic of this allocation in retirement. This can be achieved by shifting your allocation by 1.5% from stocks to bonds with each year. For the ratio of the above funds at years until retirement, for example,

25 years to go (60%/30%/8%/2%)
15 years to go (50%/25%/20%/5%)
5 years to go (40%/20%/32%/8%)
At retirement (35%/18%/38%/9%)

Target retirement funds attempt to do this adjustment for you and there are some of these that invest in low-cost index funds, but I usually like to have this control myself.

That’s it, not complicated.

Retirement: When will I get there?

Posted on December 16, 2018 by wiseguide

My previous post discussed determining needs for retirement life, and for our example calculated we’d need $2.1M. Ouch. But here’s the thing, remember that’s with dollars way into the future (inflation adjusted), and if you have some discipline you can get there. Here’s our approach. For our financial projections, we’ll look at each group of assets as we did with with our retirement needs, and try to figure out how they will grow with time.

Home. Your home is one of your larger assets, and should grow in price like other assets and as you pay down your mortgage. We should be ale to get a reasonable current value of our home using sites such as zillow. Though not exact, it’s reasonable to assume an increase in value of 2.5% per year. Each year we also subtract off the principal portion of our mortgage, available from your amortization schedule (Microsoft Excel has a template for this if you need it). The equity in your home equates to

Home equity = (Current home value) x 1.025^years-Principal Owed

For example, a person retiring in 35 years with a $300K home today, starting with a $240K mortgage at 4%, the home equity looks like this

2. Retirement savings. Though historical data for stocks is higher, I like to assume an average combined return of 6%, assuming you’ll be allocating assets to a mix of stocks and bonds. Hopefully your return will be higher, but this is reasonably conservative assumption. You’ll probably be able to increase the amount you invest each year, but we’ll assume this is fixed. The easiest way to calculate this is using the Excel formula for future value,

FV = (Current Value, interest rate, years, yearly deposit)

Also, remember money in a 401k or IRA is not available until age 59.5. So, for example, a 30 year old saving $7200 per year with a current account of $50K:

3. Regular Savings. Similar to the above savings, however now we don’t have the benefit of tax deferred savings like the 401k, and also part of this savings is in your emergency fund, which will necessarily have a lower return. I think a reasonable assumed return on investment is 4%, again hopefully you’ll do better. For example, a 30 year old saving $2000 per year with a current account of $10K:

4. College Savings. Assuming you have kids (congrats!) college savings is another bucket for accumulation of assets. Assuming you are using a 529 plan, these earnings are tax free, but also should get more conservative (=lower rate of return) as your child gets closer to college age. Here I recommend assuming a rate of return of 5%. For example, let’s assume you’re putting away $100 per month for your child. This probably won’t be enough to cover the whole bill, but will take out a good chunk:

Finally, we sum up all all the curves and compare it to your needs from our earlier post. For our example:

Whoa. Made it! We didn’t have to assume ridiculous returns and we didn’t have to save $50k a year! Hopefully, this shows you this is achievable. We made some pretty conservative assumptions, but we show making it to your comfortable retirement while not eating Ramen Noodles and sacrificing Netflix during your working years. Notice what it takes is discipline to save every month, and starting early.

One other big caveat. All my calculations and assumptions above show nice smooth curves as your assets grow. This is far from reality, but a reasonable estimate for projections. No one can tell you if you will definitely make your financial goal. In a future post, we’ll get into how this is really just a best guess, and calculate the probabilities of getting there.

When Do I Have Enough?

Posted on December 8, 2018 by wiseguide

money-2724235_640 “Enough” is a tough concept to answer for each person, but extremely important to define for an person’s financial goals. Remember the role of money is only to give you a happy, satisfying life. For some people “enough” means a yacht with two helicopter pads (because with just one they’d be unhappy), though I’d suggest they may have lost their perspective on what it takes to make them happy. This concept is so critical that John Bogle, the founder of Vanguard and the father of index investing, used it as the name of his book.

There is a classic bit of financial wisdom, that totally misses this point. It states you figure out your needed retirement income as a percentage of your current income, typically about 75%. This is overly simplified, foolish, and sends the wrong message. Think if you get a big raise late in your career, would you think, “Oh no, my retirement account is suddenly way underfunded!” Of course not. Further, your expenses in retirement are completely different from those pre-retirement. Instead, you want to calculate what you need for enough. This is obviously different for each person, but I suggest determining your happiness needs in three categories.

1. Lifetime income. Hopefully you’ve gone through the budgeting exercise for your current expenses. For your retirement income needs, you should go through this again, except for retirement life. Your categories will undoubtedly change quite a bit. If you’re retiring before Medicare age (65), or if you think the Government will screw this up before you get there, your medical insurance will be a significant expense. This is going up considerably every year, I’d budget at least $2000 per month for medical insurance and expenses. Also, perhaps you’re looking to travel more, golf more, eat out more, whatever, but you should have less expenses for that house mortgage (paid off!) and for kids. Again, you’re trying to define “enough” for you. Lets assume your monthly budget adds up to $5000 in today’s dollars. If you’re 30 and retiring at 65, with a 2.5% rate of inflation, this is

$5000 x 1.025³⁵= ~$12,000 per month

Once you’ve built this retirement monthly budget subtract your expected social security payment (also adjusted for inflation and if you are retiring after social security age AND you think it will actually still exist when you retire!) as well as any expected retirement pensions you might have. Multiply that number by 12 to get your yearly income need, it will look something like this:

12 x (Monthly budget -Social Security-Pensions) =Income need

e.g. 12 x ($12,000-$6000-$2000)= $48,000

Multiply this number by 25 and that is the rough amount you need to save to support the budget you developed, in this case $1,200,000, or roughly a little more than a million bucks. Multiplying by 25 follows the “4%” rule meaning you should be able to invest your money reasonably conservatively and withdraw 4% per year. This isn’t magic, and has a ton of assumptions, but is a decent best guess.

2. Home. I’m a believer that your retirement home should be mortgage free. If you are carrying a mortgage, that needs to go into the budget above, but let’s assume you are not continuing to carry debt in retirement. If you’re a homeowner now, generally your retirement home will be no more expensive, and possibly much less if you downsize. What I suggest is start dreaming about where you want to live, and what kind of house will make you happy. Use sites like Zillow to see what that house costs. Once again, adjust for inflation as we did for the budget above, and there is your number. If you really, really want another big purchase (like that second helicopter) include this cost also. But please, try not to believe you need a helicopter. Or two.

3. College. If you have kids not yet in college, and you believe it is your obligation to pay for it, this is the third big expense. I’ll have a separate post on saving for college, but in summary a good place to start is the current in-state tuition, room, and board where you live and multiply this by 1.5 for a teenager, 2.0 for a grade-schooler, and 3.0 for a baby. College inflation is pretty ridiculous. Thank your parents if they paid your way. Then multiply this by 4, for 4 years of college, and encourage your young one to finish in 4 years. Again, this could change a bunch if he/she really wants to go to that expensive private school, or grows into a world class volleyball player, but again, it’s a good guess. For example, where I live in Virginia, current tuition, room and board at UVa is $28,000. For a grade schooler, I’d plan on

$28,000 x 2.0 x 4.0 = $224,000

So now, just add them all up. For example, let’s say you figured out the $1.2 Million you need to generate the income you want, and figure you would like a $300k house, adjusted for inflation is ~$700k, and figure it will take a little over $200k to send your kid to college. The total then is ~$2.1 Million. This is your targeted net worth. That’s the minimum you will need, assuming all the assumptions above, and is a reasonable target for what you’ve determined as “enough”. Scary? It doesn’t have to be, and I’ll show you how to get there. If that’s too big a goal, you can make some adjustments to your future lifestyle, or decide to work a little in retirement or junior’s college choice. Also, if your goal is to retire prior to social security age, I’ll have a separate post on retiring early and how to define this need. The point is to have a definitive goal to shoot for that has some relationship back to what you feel you need.

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