Retirement – Your Personal Finance Pro http://yourpfpro.com Personal Finance for Young Professionals Thu, 18 Jan 2018 17:48:44 +0000 en-US hourly 1 31591919 Should You Delay Retirement Until Forced? http://yourpfpro.com/delay-retirement-forced/ http://yourpfpro.com/delay-retirement-forced/#respond Wed, 29 Nov 2017 17:45:55 +0000 http://yourpfpro.com/?p=7522 Retirement is a subject not everyone likes to talk about. After all, who wants to admit they are getting older? Thinking about it can cause feelings of depression, fear, and anxiety. For instance, some people have concerns that they will be lonely or bored without having a job to go to every day. They may […]

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Retirement is a subject not everyone likes to talk about. After all, who wants to admit they are getting older? Thinking about it can cause feelings of depression, fear, and anxiety.

For instance, some people have concerns that they will be lonely or bored without having a job to go to every day. They may picture themselves sitting in a chair as they watch television and wither away with age.

Aside from those fears, there are other reasons you may wonder if you should delay retirement until forced.

Benefits of Delayed Retirement

Money Won’t Be as Tight

Working longer provides a steady income for more years which allows older workers to save more before retirement. Of course that infers that they budget their money and actually save during those years.

Higher Social Security Benefits

There is real worry among Gen Xers over the possibility that Social Security income will either fall short of their needs or not be available at all. At least part of those fears has been fed by the media.

According to some predictions it could run out around the year 2033, which is only 15 years away. But with some small changes, it could be extended until the late 2080’sor so, which buys time to fix the issues Social Security has.

But it could also help if as many of the older generation as possible delay their Social Security benefits until they are age 70. It allows the funds to grow rather than be depleted faster.

For the single aging worker the advantage is that the monthly benefit amount could be higher which can help with rising inflation and expenses. Although, waiting longer than age 70 most likely won’t increase the benefits they receive.

Larger Investments

Waiting to retire until they are forced can help the older work force when it comes to investments. It allows them a longer period of time to make changes and invest more toward the coming retirement years.

Additionally, working longer gives the aging work force the opportunity to invest in ways they may not have thought of previously, such as in real estate or mutual funds.

Disadvantages of Earlier Retirement

Money Could be Tight

If working longer provides income for more years then obviously the opposite is true of earlier retirement.  It may be harder for older workers to pay their monthly bills when they retire “on time” or early.

Social Security Benefits Will Be Lower

Once again, earlier retirement has the opposite effect on Social Security benefits of waiting longer to retire. The monthly benefits will be lower since it will potentially be spread over a longer period of time.

Smaller Investments

In addition to the other early retirement disadvantages older workers face they would also have less time for their investments to grow. This results in less money to go around for all of their bills.

These disadvantages could pose real concerns for the aging population about inflation and rising medical costs among others. But how can the problem be resolved?

Become Better Prepared

Develop Better Spending Habits

One way to prepare for retirement is to start changing spending habits now. Whether retirement is forced or voluntary Gen Xers can still make changes to impact their finances before retirement happens.

Along with changes in spending habits older workers can create a budget if they don’t already have one.

Making cuts in their spending in areas that make sense, such as frivolous or unnecessary spending, can also help. Some examples include, spacing out salon visits, eating out less, or changing from cable to streaming to watch television.

Pay Off as Much Debt as Possible

Getting debt paid off so they can retire with more income and fewer bills hanging over their heads is another good idea. They should pay more than the minimum payment on loans. Not only does it reduce the interest they will pay on the debt it will also pay it off quicker.

Review Insurance Plans

Sometimes people get stuck in a rut and simply keep paying every month on the same old insurance policies. But perhaps they should instead pay attention to the cost of the premiums as compared to the benefits and how they change over the years.

They should review their health insurance policy to make sure it not only meets their health needs but also works for their finances. In addition they should look at other policies such as home owners insurance, auto insurance, and life insurance to make sure changes are made if they are necessary.

Whether or not you should delay retirement until forced is up to you. But it is far easier to reach a decision when you know some of the facts involved first.

How do you feel about retirement?

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3 Affordable Places to Retire Abroad http://yourpfpro.com/affordable-retire-abroad/ http://yourpfpro.com/affordable-retire-abroad/#comments Wed, 08 Apr 2015 13:30:07 +0000 http://yourPFpro.com/?p=6048 While some of us reading Your Personal Finance Pro may be years away from retirement, it’s never too early to begin planning for the future. Whether you continue working full time, part time, or not at all, have you thought about where you’ll be enjoying your retirement years? You may assume you’ll stay where you […]

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While some of us reading Your Personal Finance Pro may be years away from retirement, it’s never too early to begin planning for the future. Whether you continue working full time, part time, or not at all, have you thought about where you’ll be enjoying your retirement years?

You may assume you’ll stay where you are in retirement, but what if your house doesn’t suit your needs, or the area isn’t conducive to aging in place? It could be that your children end up on different sides of the country, and it doesn’t make sense to keep a permanent residence at all.

And then there are those of us who want the best of everything: the ability to pack up and leave at any time, travel when we want, and most of all, have it all be affordable. While I’m not an expert on California or Hawaiian real estate, common sense and a glance at Zillow tells me my dream of retiring to a beach oasis on a frugal budget won’t be possible. However, it is possible to have that beach getaway and still be able to afford my older age medical bills – in another country.

Retiring for Affordability: Nicaragua

One of the criteria on my list when I retire is access to a beach, but a close second is affordability. If you’re looking to retire to a beautiful location and save money, you’ll want to look at Nicaragua. The Pacific coast of Nicaragua is beautiful and affordable, particularly San Juan del Sur. This small town is nestled into a bay, with forested hills and mountains to the north. It is known as a tourist-friendly destination in Nicaragua with some of the country’s best beaches.

Most importantly, it’s fairly easy to live in Nicaragua for under $1,000, depending on much house you decide to rent. International Living states that while Nicaragua is less developed than what many of us are used to, you can often get more for your money in terms of luxuries (like a maid, gardener, etc.)

As with many countries, the best health care will be found in a major city and not necessarily in a smaller town. Hospitals and doctors in the bigger cities, like Managua and Granada, provide high-quality health care at affordable prices. Your options may be limited in smaller towns, although you’ll likely have access to basic treatment and common prescriptions. That said, Americans can purchase MedEvac insurance in case of an emergency that can’t be treated in Managua, Nicaragua’s capital.

Note: Nicaragua is listed as “critical” by the Department of State in terms of security. Do be aware that Nicaragua’s high crime rate is not only due to crime, but also due to very low rates of apprehension and conviction of criminals. Police coverage in Nicaragua is not what most Americans are used to. Also note that while the tourist-friendly cities and capital city of Managua likely have many expats and others who speak English, it’s in your best interest to find an expat community before you go to Nicaragua, especially if you don’t speak Spanish. These expats will help acquaint you with the country and can provide on-the-ground information about places to visit.

Retiring for a Mix of Affordability and Creature Comforts: Costa Rica

If you haven’t yet heard about how Costa Rica is a haven for expats, it’s time to check out International Living’s extensive write-up, or many of the other articles devoted to Costa Rica. Not only is Costa Rica well known for its expat population, it’s also known for its incredible biodiversity, from the cloud forests to the beautiful and extensive beaches. If you’ve ever wanted to get lost in the jungle, hiking, kayaking, ziplining through the trees and more, Costa Rica is the place for you.

Costa Rica is the most expensive country in Central America, but you will find a high standard of living for much less than it costs in the US, Canada, or Europe. International Living estimates one person would spend approximately $1,200-1,500 a month, including rent. Health care in Costa Rica is cheaper too, with International Living estimating health care costs at one-third to one-fifth the cost of health care in the US.

Costa Rica has a high number of expats, with around 50,000 living there at any one time. If you don’t speak Spanish, it’s likely you’ll be able to get around fine living in a bigger town with a higher number of expats. Also, if you do get homesick occasionally, you’ll have other people around to remind you why living in Costa Rica is beautiful – and how you’re only a flight away from the US.

Retiring for More Luxury, Still More Affordability: Mexico

Retiring to Mexico, even part-time, is an easy way to combine a lower cost of living with the creature comforts of home. It’s a fairly short flight between Mexico and the US, which makes Mexico a convenient location when you have to return home for family or other events. Finally, the cost of living is much less expensive in Mexico than in the US, depending on where you want to live and how much luxury you want. International Living estimates living in Mexico will cost around $2,000 a month, including a maid and a gardener.

If you decide to become a Mexican resident and obtain a visa, you also get special medical and cultural benefits as an older adult. Mexico has a program called Personas Adultas Mayores, which is a benefits program offering a wide range of discounts on services. Services include health-related costs, like hospitals, pharmacies, and dental work, cultural activities like entrance fees to archeological sites, and discounts on hotel stays and stores. Discounts range from 5-50% off the full price of the services or goods.

As I mentioned in my medical procedures post, health care in Mexico is very good. Doctors and dentists are often trained in the US, and procedures are a fraction of the cost in the US. As always, try to find an expat community ahead of time, particularly before scheduling any medical procedures, to get first-hand information and answers to your questions.

Both sides of the Mexican coast are very good locations to live, although I’m partial to Cabo San Lucas’ and Puerto Vallarta’s beaches. The cost of living will increase on the coast, due to rent, although you may be more likely to find more expats and people who speak English fluently. If you choose to live inland, do some research ahead of time, as some locations in Mexico are more crime-plagued than others.

You’ll notice that in all of these scenarios, I reference renting accommodations versus purchasing a house. In addition to not knowing if you’ll love some place forever, renting also gives you the ability to return to the US if you want to. By not purchasing a home, you’re free to leave whenever you want, for whatever reason (whether it’s an illness, family event, or general boredom). Other countries laws and law enforcement also differ from the US, and no one wants to deal with the hassle of buying or selling property in a foreign country with unfamiliar laws.

These locations are but a fraction of luxurious-yet-affordable places you could retire to – I didn’t even tackle South America, let alone Asia. Also, I focused on beach living simply because beach living is delightful to me. However, with a little research, you’ll likely find many places are more affordable to retire to than the US, Europe, and Canada. While retiring abroad isn’t for everyone, it’s certainly an option for those who are a little more adventurous, in better health, and who want the outdoors to be their playground. Is retiring abroad an option for you?

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Prioritizing Debt vs. Retirement http://yourpfpro.com/prioritizing-debt-vs-retirement/ http://yourpfpro.com/prioritizing-debt-vs-retirement/#comments Wed, 25 Mar 2015 13:30:26 +0000 http://yourPFpro.com/?p=6024 For those of us in our twenties and thirties, retirement seems fairly far off and remote. After all, when you’re planning school, buying your first home, or traveling the world, let’s face it: thinking about your “golden years” is pretty far down on your list. However, as the news media likes to remind us, all […]

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For those of us in our twenties and thirties, retirement seems fairly far off and remote. After all, when you’re planning school, buying your first home, or traveling the world, let’s face it: thinking about your “golden years” is pretty far down on your list. However, as the news media likes to remind us, all we have to rely on for retirement is ourselves – not our pensions (if you have one) or Social Security.

Regardless of your thoughts on Social Security’s longevity, the news media does get one thing right: we really do only have ourselves to rely on when by the time we reach retirement. We can no longer expect anyone to provide us with a livable wage in retirement and guaranteed health care (or, at least the quality of health care you’d like to receive).

However, when you have student loans (or other debt) to pay off, are trying to save up for medium-term goals, and have to save for the longtime goal of retirement, it’s confusing to determine where to allocate your income. Whether you’re underemployed, entry-level, or making a good salary, there is a system you can follow to make the most of your money – all while still addressing debt and saving.

The 50/30/20 Rule

The 50/30/20 rule is one way to efficiently tackle all your expenses. Instead of saving intensely, and neglecting your debt, or paying off debt and ignoring your emergency expenses, this rule helps you divide up your income and cover all bases. It works like this:

  • 50% of your take-home pay should go to essential expenses, like housing, utilities, transportation, and groceries (note: not entertainment and going out to eat!) The 50% rule is for the bare minimum amount you need to survive.
  • 30% of your take-home pay should go to lifestyle choices, which is all of the fun stuff that make life worth living. This includes saving up for travel, gifts, Internet, going to the gym (or making your own home gym).
  • 20% of your take-home pay should be put toward financial priorities, including your debt, retirement and emergency savings.

Does your “bare minimum” (50% of your salary) take up more than 50%? You may want to consider moving closer to work to lower transportation costs, or move farther away if it means a cheaper cost of living. And yes, you can allocate more than 20% of your money to your financial priorities, if you can.

About That Debt…

Let’s say you have the 50/30/20 rule down, but you’re still not sure about that debt you have. When you’re young, shouldn’t you focus on paying off debt and save for retirement once you’re settled? Well… yes and no. Helpful, huh? Here’s a rough guide for when it’s better to pay down debt and when it makes more sense to save for retirement.

First, a quick note: save something for retirement, no matter how small. Most financial advisers typically recommend you save 10% of your take-home pay for retirement (part of “paying yourself first”), but sometimes that’s hard on a small salary. The best advice is to save what you can. If that’s only 5% of your salary, save 5%! The power of compound interest is too important when you’re young!

Once you have a small retirement savings, take a look at your debt. What kind of debt do you have?

  • School loan debt: depending on how much your interest rate is, you may be better off paying the minimum on your student loan debt for a variety of reasons. First of all, you can deduct $2,500 in student loan interest from your taxes, so if you pay $2,500 or less a year on student loan interest, you can write it all off. Second, if you’re in the student loan Public Service Loan Forgiveness program (you work in public service, including the government and certain nonprofits), you can be eligible to have your loans forgiven in 10 years or less.

If student loan debt is taking a large amount of your take-home pay, look into an Income Based Repayment plan to consolidate and possibly lower the amount you pay monthly on your student loans.

  • Home loan: mortgage interest (on first and second mortgages) is also tax deductible, so it may make more sense for you to continue paying the minimum on your home as well. Particularly if you plan on selling your home (for a profit) in a few years, it may make the most sense for you to pay the minimum and pay off the house when you sell.
  • Credit card debt or auto loans: in most cases, pay this debt off first! Credit card and auto loan interest rates are usually higher than student and home loan interest, which means paying off this debt will cost you less in the long run.

Remember: these are all general guidelines. If your student loan debt is held by a private company that charges you 7% or more in interest, and your car loan is only 4%, tackle the student loan debt first. This may mean you try to consolidate your debt at a lower interest rate, or try to negotiate with your loan holder, but the bottom line is you’ll end up paying more on your student loan than your car (in that scenario). Pay off your highest interest rate debt first, no matter if it’s credit card, auto, or student loan to save yourself money in the long term.

If you’re a long-time Your Personal Finance Pro reader, you already know how important it is to not rely on anyone but yourself to pay for your retirement. However, without a plan, it’s difficult to know if you should pay off all your debt first, and save money later, or save a small amount while paying off debt.

Although it feels more satisfying paying off every single one of your debts, it won’t feel that great if you’re 35 or 40 and only just beginning to save for retirement. Slow and steady wins the race and, as you get raises, consider splitting your raise and putting half in retirement and half to increasing your debt repayment. You will eventually pay off your debt, plus you’ll benefit from years of compound interest.

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Money Goals to Set for 2015 http://yourpfpro.com/money-goals-for-2015/ http://yourpfpro.com/money-goals-for-2015/#comments Wed, 10 Dec 2014 17:15:40 +0000 http://yourPFpro.com/?p=5739 I’m big on setting goals that are achievable.  I don’t try to tackle too much and sometimes it’s as simple as just doing 1 thing better over the next year.  Today, PF Pro contributor, Kali Hawlk takes a look at some money goals that you can set for 2015.  This is also Kali’s last post […]

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I’m big on setting goals that are achievable.  I don’t try to tackle too much and sometimes it’s as simple as just doing 1 thing better over the next year.  Today, PF Pro contributor, Kali Hawlk takes a look at some money goals that you can set for 2015.  This is also Kali’s last post for the blog so I wanted to say thanks for all her hard work over the past year!

We’ve only got a little more than two weeks left in 2014, which means it’s time to start thinking about the New Year. If you’re eager to set some resolutions you can actually work toward and keep to make 2015 even better than this year, consider setting a few goals with your money.

Creating a better financial situation is something you can work toward every week, every month — and you don’t need to make drastic changes. Baby steps, taken consistently over time, will get you there.

And don’t forget: there are countless ways to improve your personal finances. Not sure where to start? Consider these money goals to set for 2015:

Establish Financial Security

Did you experience a money scare or two in 2014? Make 2015 better by working to build up your financial security. There are two main ways to achieve this: pay down debt and build up savings.

Have you established an emergency fund? If not, make that your money goal for 2015. Set aside $10, $20, $50, or $100 per week until you have at least $1,000 secured in an easily-accessible (and liquid) account.

It’s okay if progress is slow. You have 12 months to meet these goals, right? It’s more important that you just get started.

If you already have an emergency fund, consider adding to it. Ideally, you’ll have 3 to 6 months’ worth of living expenses or net pay saved up. But adding to that provides additional financial security — especially if you’re self-employed or have heavy financial responsibilities (i.e., you have multiple dependents that rely on the income you produce).

If you have debt, it’s time to make a plan to start paying it down aggressively. Get mean! Do what you can to free up as much money as possible each month to put toward your debt, so you’re paying way more than the minimum and crushing that debt fast.

Already paying down debt? Consider ways to accelerate your progress. (My favorite method: side hustle!)

And there’s one more way to set money goals for 2015 that can help you build financial security. Consider getting the right protection for your assets and yourself if you don’t have it already. That means, depending on your situation, getting:

Not everyone will need insurance out the wazoo, but it’s important to consider. Look at your own situation, do your research, and determine what your personal needs are.

Build Your Wealth

Everyone should have this money goal on their list for 2015. Let’s all make a New Year’s resolution to build wealth!

We can do this by:

  • Making sure we’re contributing to employer-sponsored retirement accounts and securing the match, if that’s available
  • Also establishing a traditional or Roth IRA — this is a must of an employer-sponsored account isn’t available to you
  • Using a SEP IRA if you are self-employed full-time or part-time (if you have a side hustle, you can contribute!)

That’s the easiest way to get started. Work to contribute at least 15% to 20% of your gross income to your retirement accounts. If you want to get serious about wealth-building, aim for 30% to 50% — or more.

When it comes to investing in these accounts, I prefer passively managed index funds.

You can also invest outside of retirement accounts, but take advantage of those first because they’re tax advantaged. (An invested savings account, for example, won’t be tax advantaged, at all.) If you qualify, you might also want to look into an HSA.

And you can invest in yourself, too! Continue your education. Pick up a new skill or ability. Add to your experience that can pay off in a tangible way in your career or money-earning ability.

Use Your Money Goals to Live the Life You Want!

Your 2015 money goals can be a little more intangible, or at least different than what someone else might be working toward. Your money goals might revolve around gaining access to the life you want.

Make your goal to save up for a home down payment if you’re ready to have a place to call your own.

Educate yourself on the trip you want to take and look intro travel hacking to make the most of your money (then save up for the rest, too!).

Work to be in the financial position where you can take time off to volunteer is important to you.

Aim to earn more in 2015 by negotiating a raise or starting your own side hustle — or even side business.

The possibilities here are endless. Take a moment to think about what the life you want to live looks like — then start drawing up a plan to meet some of the money goals you’ll need to get there in 2015.

Finally, take action. A new year is a good excuse to start something, to establish new goals to work at. Just make sure that you finish them, too.

What money goals will you work toward in 2015? What are you hoping to accomplish in the new year?

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Are You Saving Too Much for Retirement? http://yourpfpro.com/saving-much-retirement/ http://yourpfpro.com/saving-much-retirement/#comments Wed, 01 Oct 2014 17:20:36 +0000 http://yourPFpro.com/?p=5458 Over the weekend, I skimmed past a headline that read: You Might Be Saving Too Much for Retirement. Cue screeching tires coming to a halt. Scratching of abruptly stopped records. I did a digital double-take and quickly scrolled back up on the Twitter feed I was reading on my phone. What kind of nonsense is […]

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Saving Too Much for RetirementOver the weekend, I skimmed past a headline that read: You Might Be Saving Too Much for Retirement.

Cue screeching tires coming to a halt. Scratching of abruptly stopped records.

I did a digital double-take and quickly scrolled back up on the Twitter feed I was reading on my phone.

What kind of nonsense is this? I thought. I clicked on the link, and I was disappointed to find the article was pretty much a bunch of nonsense.

It was written by an individual already well into retirement today, who was into their 70s, and who took advantage of current Social Security rules that provide you maximum benefits if you wait til 70 to start withdrawing them. This individual had played by the book, financially speaking, and was a diligent saver during their working years and paid off the mortgage to the home they planned to live out their days in before they hit retirement.

They had an ample nest egg and no debt. Their Social Security all but covered their necessary expenses, leaving all that money they’d saved up available for discretionary spending. They concluded they had saved too much while they were working, and regretted not “living it up” a little more while they were young.

Today’s Retirement Won’t Look Like Tomorrow’s

There was nothing particularly wrong about the article — beyond the fact that it was completely irrelevant to the age group who needs to be thinking about retirement savings more than any other. That’d be Gen Y, or those in their 20s and 30s, because they’re in the prime position to take advantage of compound interest and save a whole butt-load as soon as they can (that’s the scientific term, you know).

The biggest reason that it’s irrelevant is because of the heavy emphasis on the fact that Social Security was footing most of the necessary bills. I do believe some form of government benefit will exist for retirees by the time we hit retirement age, but I don’t think it will look anything like it does today. I’m not factoring it into my retirement plan; if something’s there, it’s a bonus.

It’s also irrelevant to Millennials because the vision of retirement is constantly shifting. Our retirement won’t look like the life of a retiree today.

But still — the idea that this person said they should have lived it up more while they were young stuck with me. It left me feeling a little uneasy.

How Much Is Too Much?

That is, of course, because I’m a bit of a money hoarder. I prefer saving to spending, and not because I’m cheap (at least, not most of the time).

The lifestyle I lead simply doesn’t cost a lot of money. When I do spend, it’s usually on big stuff — namely, travel, both domestic and international. 

So instead of spending, I save. A lot. I don’t have to worry about debt or getting into financial trouble because I spend too much. But interestingly, saving money — and investing the majority of it for future needs like my ideal retirement — has come with its own set of worries.

The one about not enjoying life today because I’m too busy worried about tomorrow is prime among them. That’s why the article stuck with me, perhaps a little longer than it should have.

How can you strike a balance? How much is too much saving and too little living?

It scares me how often I hear people talk about what they regret not doing. I wonder if, by striving to save as much as I can (without landing myself on Extreme Cheapskates), I’m depriving myself of a critical experience or opportunity I won’t get in the future.

On the other hand, part of me thinks that’s “fear of missing out” talking. Those thoughts are fear-based. They’re not rational.

Am I saving too much for retirement? No! It has nothing to do with how much I’m saving and everything to do with the question, am I enjoying life right now or am I feeling deprived because I prioritize saving over spending?

My answer to that question: I love my life right now. I don’t feel like I’m deprived or missing out on anything critical. I don’t want for much and I’ve learned that I’m happiest when my money goes toward things I highly value. Again, for me, that’s travel. Food is a close second. (Seriously!) If someone asks what I want, I tell them, “I want to go on a trip.”

And I do. So I’m happy with my life today. And I’m really thrilled that my savings rate allows me to grow my wealth to enjoy life just as much tomorrow, too.

No, You’re Probably Not Saving Too Much for Retirement

I think anyone who’s working hard to save for retirement wouldn’t mind their future selves beaming back through time to tell them, “you know what? Everything works out fine. Stop worrying so much about money and enjoy it a little more. You can spend a little more and still have plenty in retirement.”

But that’s not gonna happen. You just don’t know — good or bad — what the future looks like.

We want someone, an authority, to tell us, “yes, you’re saving too much! Look at these models that show you’re in better financial shape than you thought you would be.”

But they don’t know any better than we do what tomorrow brings.

We want permission to get a little lax with saving because we’re doing so much. And it’s exhausting. It’s a long hard slog to reach a big financial goal, like adequate savings for retirement — or enough wealth for early retirement. Having someone say we’re saving too much would be a bit of a relief, because it might mean getting to ease up a bit.

You’re probably only saving too much for retirement if:

  • You’re depriving yourself of any pleasure or happiness today in order to save a buck for tomorrow.
  • You agonize over spending purchases.
  • You go out of your way to save a dollar; you spend two hours clipping coupons to save $5 (that time could be better spent earning more money!).
  • You’re miserable or missing out on opportunities and experiences on a weekly or monthly basis, because you turn them down in order to save money instead.

If, on the other hand, you…

  • balance your saving with spending on things and experiences you value above anything else;
  • enjoy hobbies or activities that are inherently inexpensive;
  • don’t find yourself wanting for anything, and therefore don’t feel the need to spend on luxuries;

…your savings rate is probably really healthy and doing great things for you on the wealth-building front. So keep it up — and don’t be fooled into thinking you’re saving too much.

 

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Do You REALLY Know How Much You Need for Retirement? http://yourpfpro.com/how-much-you-need-for-retirement/ http://yourpfpro.com/how-much-you-need-for-retirement/#comments Wed, 11 Jun 2014 12:45:53 +0000 http://yourPFpro.com/?p=4890 Do you know how much you really need for retirement? Is it 8 times your ending salary? Is it 25 times your annual expenses at the age you’re leaving work for good? Or is it simply whatever saving 10% of your income for 40 years happens to be? Determining a specific number for retirement is tricky. […]

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Do you know how much you really need for retirement?

Is it 8 times your ending salary? Is it 25 times your annual expenses at the age you’re leaving work for good? Or is it simply whatever saving 10% of your income for 40 years happens to be?

Determining a specific number for retirement is tricky. There are way to many variables in play here to make a single formula sensible for every person asking this crucial question.

But we have to come up with some sort of financial goal to aim for, a number we can hit that says, “okay, it’s reasonably safe to assume you can stop relying on a paycheck and start pulling from your nest egg now.”

Understanding how much you need for retirement is a process that may take you some time to work through. Don’t rely on a simplistic calculation to provide you with a realistic answer, or any online tools that simply ask your current age, when you want to retire, and what you’re making and saving now. Instead, consider all the factors in play for your specific situation, and how those may affect your retirement number.

Understanding What You Want Out of Your Retirement

Most formulas or calculators that show you how much you need for retirement present a problem because they go off a standard set of assumptions. They might assume you’ll retire at 67 (or, for Millennials, even into your 70s) or that you’re saving 10% of your income for the next 40 years. Or they’ll assume if you’re making $50,000 today, you’ll be spending every cent of $50,000 annually in retirement.

But what retirement looks like has changed. Your ideal retirement may be early retirement, a la Mr. Money Mustache. You might want to retire from a 9 to 5 office job in order to switch to pursuing other work you’re passionate about. You may want to move to a tropical location where your living expenses are half what they might be in the United States — or you might have a nice piece of land in the mountains that you want to use to get away from it all in retirement.

Knowing how much money you need starts with understanding what the retirement you want looks like.

From there, you can begin to estimate your annual expenses. Do your research to find the answer to the following types of questions:

  • Where do I want to live?
  • Will I have a paid-off residence or will I have a mortgage/rent payment?
  • What will my fixed monthly expenses look like (think utilities, car payments, groceries, gas, etc)?
  • What kind of purchases — beyond my bills — will I make on a regular basis?
  • What kind of purchases will I want to make occasionally, and how will I budget for that?
  • What do I want to do with my time (do you want to do part-time work, immerse yourself in a hobby, or travel)? How much money will spending my time this way likely cost me?
  • How will I account for the realities of getting older, like increased medical expenses and end-of-life care?
  • Will I have any ability to make extra income if I absolutely have to? How will I do this?
  • What will my tax obligations look like?

Yes, these are tough questions to know the answers to. Try to estimate high on your expenses and low on your income to get a “safe” number, and remember — these are supposed to be educated guesses. Again, do your research. Ask questions. And don’t forget to consider inflation.

Once you have an idea of your annual expenses, consider how long your income will need to be covered by your retirement savings. Want to retire at 60 and estimate your annual expenses to average $45,000? You’d likely need around $1.3 million in retirement savings (because I’m being positive here and want you to live a long healthy life into your 90s).

Of course, this assumes that your money will stop earning returns the moment you start withdrawing from your nest egg, which is obviously not realistic. But it’s also not realistic to say, even with all the planning on the world, that you won’t have a year in retirement when you spend more than your average $45,000.

And remember, there are many different ways to actually reach this number. If you save 10% of your income for 40 years, that might be one way. Or you could start saving in your 20s, save 50% of your income, and hit your magical $1.3 million much sooner than 60 — though the years your nest egg now has to last, if you start drawing off of it sooner, have increased.

As you can see, there are countless different ways to consider your numbers and tweak them accordingly. Do just this! Play around and run different scenarios to see how the numbers change as you modify spending and saving habits.

How Much You Need for Retirement Depends on Your Income Sources

For Gen X and Gen Y — or those in their 20s, 30s, and 40s — retirement is likely going to look much different in the future. Not only are we living longer, but we also have a different understanding of our careers and work.

Our generations were not incentivized to work 40 years with a single company. There are no pensions waiting for us as a reward for company loyalty. Instead, we’re more interested in finding work that’s meaningful (and this is especially true for Millennials). We have no problem moving from business to business to find a more fulfilling career and after seeing massive layoffs during the Great Recession, we’re less likely to assume our companies will take care of us through good times and bad.

Gen X and Gen Y are also full of entrepreneurs and nontraditional workers (think independent contractors and freelancers) who have succeeded in making their passion into paying work.

All this adds up to two generations who are unlikely to work work work as employees of a single company before retiring to do nothing but rock on the front porch all day.

We’re more likely to continue making some sort of income during our retirement years, via part-time work, hobbies that we’ve monetized, or businesses that we still own but have outsourced the labor on.

Having a separate source of income — even if it’s just a little money each money — drastically changes the number you must have saved up for retirement since you’re not relying 100% on your nest egg to cover all your expenses and spending.

And of course, if you are one of the lucky individuals who still has access to a pension, then that will change your numbers as well.

Calculations to Try (If You Just Need that Hard Number Handed to You)

Of course, coming up with a precise number on your own is difficult. It’s a lot of research, number-crunching, and scenario-running. The good news is there are some calculations that you can use to ballpark how much you need for retirement that take a tremendous range of factors into consideration.

Try these calculators and see how inputting different values for different variables affects your outcomes:

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Diversify Everything http://yourpfpro.com/diversify-everything/ http://yourpfpro.com/diversify-everything/#comments Mon, 03 Mar 2014 14:19:29 +0000 http://yourPFpro.com/?p=4053 Whenever I hear someone get really excited about their latest investment, I tend to think the worst.  It’s not that I don’t want that person to succeed but I usually worry they’re making a big mistake.  Any time I see a friend buy a house, I wonder if they spent more than they can afford. […]

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Diversify EverythingWhenever I hear someone get really excited about their latest investment, I tend to think the worst.  It’s not that I don’t want that person to succeed but I usually worry they’re making a big mistake.  Any time I see a friend buy a house, I wonder if they spent more than they can afford.  Any time I see a friend buy a new car, I hope for their sake that they paid cash and aren’t going to have an egregious car payment every month on a rapidly depreciating asset.

I can’t help but feel sorry for a lot of these people since most of them are going to have to learn the hard way about living within their means.  And there’s really nothing you and I can say or do that will change their mind since it takes a real financial epiphany(like losing your job and realizing that you’ve been living paycheck to paycheck on a 100k annual salary) before they’ll make any real changes.  So most of the time I just keep my mouth shut and worry about my own plan.

I’m Boring

Since I run a personal finance blog, a lot of people assume that I must invest in some pretty game-changing stuff.  But the truth is, my investment style is actually pretty boring.  I try to maximize returns while taking on the least amount of risk all while keeping things as simple as possible.  I know that the stock market is very efficient, thus any time something sounds too good to be true, it probably is.  If you’re getting above average returns, it’s probably because you’re taking on above average risk, simple as that.

One of the things I’m always worrying about these days though is my diversification strategy.  Most people know that it’s important to diversify their investments between stocks and bonds but what about the other areas of your finances.  I think diversification plays a huge role in every aspect of our financial life yet most people overlook it.  Here are all the ways I’m currently trying to diversify my financial life:

Stocks & Bonds

Like I mentioned, this is the most obvious area to diversify in since it just doesn’t make mathematical sense to invest in a single stock(that’s called uncompensated risk).  Professional money managers that get paid millions of dollars a year can’t consistently pick winning stocks so why should I waste my time even thinking I can?  Since I’m so young, I hold about 90% of my retirement accounts(401(k), Roth IRA and HSA) in stocks and the other 10% in bonds(as Dave Chapelle would say, “don’t forget to diversify yo bonds“).

My stocks are broken up into 60% US Stocks and 40% International Stocks.  It’s important to diversify with international stocks since your entire active income usually depends on the fortune of the US economy.  A lot of people fail to consider that their job security and salary depend heavily on the fortunes of the US economy.  Adding in some international stocks is a nice hedge in case things go south here in the US.  You don’t want to lose your job and your portfolio at the same time.

Within my domestic stocks, I also diversify 10% into small cap companies and within my international stocks I diversify 10% into emerging markets.  It’s a pretty common strategy to tilt towards emerging/growing markets since those stocks tend to have higher returns(but more volatility).

Active Income

When I quit my last job to move up to Orange County with my fiancee, everyone I talked to thought I was crazy.  They told me there was no way they’d ever be able to take that kind of risk.  All along though I was thinking to myself, what’s the risk?  I might not find another high paying job but so what, I was prepared for that scenario.  At the time, I had four additional streams of income coming in: coaching income, blogging income, freelance writing income, and rental property income.  Obviously those additional sources of income didn’t equal my day job salary but they didn’t require 40 hours a week of work either.  And the nice thing about all those secondary sources of income was that I would be able to continue doing them no matter where we moved to.

One of my pet peeves is that I hate depending on other people for anything in life.  It’s easy to get comfortable doing the same routine day in and day out taking home a nice paycheck from your day job.  But you have to remember that there’s no loyalty in the corporate world.  You can be fired at any time for almost any reason and you’re always at the mercy of your employer.  Even though my day job income makes up a majority of my income, I will never depend on it.

Real Estate

Real estate is an area where people tend to either over diversify or under diversify.  This is one of the battles I’m struggling with right now since I think real estate is a great investment but I don’t want it to make up more than 35-45% of my net worth.  Housing prices are already starting to creep up to pre-housing bubble levels and it seems like buying a house in Southern California at least is mission impossible.  I can’t even afford to buy a house in areas that I don’t want to live up here in Orange County.

Real estate over diversification is an easy trap to fall into since banks generally loan out more money than most should ever accept.  But not many homebuyers are going to turn down free money(see subprime mortgage crisis).  Housing is also a very illiquid investment since once you put money in, it’s a lot harder to get it out.  There’s a lot of pressure though to be a homeowner and I think this forces people to buy houses that make up way too much of their net worth.  It’s tough to fight the herd and go at your own pace when all your friends are buying nice houses, but that’s what you have to do if you want to be a smart investor.

Alternative Investments

I don’t think alternative investments are a necessary portion of a successful portfolio but they can serve an important purpose.  With investments like Lending Club or start-up type funding, there are huge rewards for taking on additional risk.  I’m getting a 12% return in my Lending Club Roth IRA right now and it feels great.  I’m outperforming the stock market and even though it’s only a very small portion of my portfolio it satisfies my hunger to actively trade.

Alternative investments also keep you grounded though.  If you decide to do a little active trading with 1% of your portfolio and you lose it all, that was a very cheap but valuable lesson.  I try to limit my alternative investments to 5-10% of my portfolio.  Currently, my Lending Club Roth IRA is my only real alternative investment at around 4% of my portfolio since I recently sold all my American Airlines shares.

Taxes

Taxes are the last part of my diversification strategy.  A lot of people overlook tax diversification because they’re so focused on the other stuff.  But diversifying from a tax perspective is just as important as your stocks and bonds diversification strategy.  The common pre-tax vs after-tax argument is that your income in retirement will be lower than your current income so you should contribute more to pre-tax accounts like a 401(k) and traditional IRA now.  But if things go the way I want them to, my income will actually be higher in retirement than it is right now.

The second thing you have to consider is the future of tax rates.  I have no idea where they’re headed and neither does anyone else.  You might think taxes are high right now, but did you know the highest marginal tax bracket in the 1940’s was over 90%?  The truth is, we might have an idea of where our income will be in retirement but we have no idea where taxes will be.  I like to contribute at about a 3:1 ratio of pre-tax(401(k) & HSA) to after-tax(Roth) in order to achieve adequate tax diversification.

I wouldn’t want to enter retirement with a $5 million portfolio and have to pay taxes on all of that money due to some new liberal president.  Conversely, I also don’t want to pre-pay too much in taxes right now since rates could go lower, my income could go lower or the government could impose a total asset based tax that would affect Roth IRA’s.

Readers, what do you think about my strategy to diversify everything?  Did anything stand out or is there any one area that you would diversify more/less?

-Harry @ PF Pro

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No 401(k) Available at Work. What To Do? http://yourpfpro.com/no-401k-available-at-work-what-to-do/ http://yourpfpro.com/no-401k-available-at-work-what-to-do/#comments Wed, 26 Jun 2013 16:48:19 +0000 http://yourPFpro.com/?p=2373 I received an interesting question the other day about a topic I hadn’t given much thought to before. A reader e-mailed me asking what they should do if their work didn’t offer a 401(k) plan. I talk a lot about asset allocation, investing strategies and making contributions to your retirement accounts but it’s a lot […]

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No 401k What To DoI received an interesting question the other day about a topic I hadn’t given much thought to before. A reader e-mailed me asking what they should do if their work didn’t offer a 401(k) plan. I talk a lot about asset allocation, investing strategies and making contributions to your retirement accounts but it’s a lot harder to implement these strategies without a 401(k), so what’s one to do?

Although most companies do offer a 401(k), not all plans are the same. In some cases, your plan might have such outrageous fees that it will only make sense to contribute up to the company match(if there even is one) and then start exploring alternatives like IRA’s and fter-tax accounts. It’s gotten easier and easier for small businesses to set up 401(k)’s for their employees but there are still some out there that don’t. I think our 401(k) system needs a lot of work but not offering one isn’t the solution.

Get Everyone on the Same Page

If you’re a W2 employer for a company that doesn’t offer a 401(k) you’re at a huge disadvantage. You are effectively losing $17,500(2013 contribution limit) worth of tax advantaged space. I would try to get all of the employees on the same page and show them how much of a disadvantage it is not having a 401(k). That way, you can all calmly and reasonably approach the boss and carefully lay out the reasons why you want a 401(k). Don’t go in and make demands, instead be reasonable yet firm that you all deserve a 401(k).

Open a Traditional IRA

The best thing about a traditional IRA is that you can open it with almost any broker and invest in anything you want, from Lending Club to CMC Markets. IRA’s are very flexible and you should choose a broker that offers low cost funds in order to maximize your earning potential. The only problem with IRA’s is that you will be limited to $5,500 a year(2013 contribution limit) so it’s not a great substitute for a 401(k).

I would probably stay away from a Roth IRA since the contributions wouldn’t be tax deductible like with a traditional IRA. And since you only get to pick one(traditional or Roth), I’d go with the deductible one since you don’t get a 401(k) contribution deduction.

1099 Income Means You Can Open a Solo 401(k)

If you get paid in 1099 income or you own your own business, then you have the option of opening a solo 401(k). Usually when an employer pays you with a 1099, it means that you are a contract type or temporary employee. You won’t get any benefits like medical and 401(k) but getting paid with a 1099 means you are self employed, and technically you now own a business. That business is you.

A solo 401(k) does exactly what it sounds like and allows you to open a 401(k) for yourself in order to deduct your business income. This is a great option for those with 1099 income since you can open a solo 401(k) pretty easily with whichever broker you choose. Things can get a little bit more complicated though around tax time, so I would probably consult with a tax specialist here.

If you have W2 and 1099 income, you can still open a solo 401(k) but the $17,500 contribution limit applies across all your 401(k) accounts. So you won’t be able to ever contribute more than $17,500 across all your 401(k) accounts. But this could come in handy if you have W2 and 1099 income and your W2 employer doesn’t offer a 401(k) or if you leave your W2 job halfway through the year and your new employer won’t allow you to make 401(k) contributions for 6 months.

Having no 401(k) shouldn’t be an excuse for not being able to save. Instead, it just means that you’re going to have to work a little bit harder. Having 1099 income makes things way easier but if you don’t, don’t give up. Losing out on $17,500 of tax advantaged space is a big deal so maybe it’s time you start looking for other opportunities in the area, or at least ask for a raise!

Readers, have you ever worked for a company that didn’t offer a 401(k)? If so, how many employees were there? I would really have to love the company to work for one with no 401(k) but I love saving!

-Harry @ PF Pro

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Everyone’s a Great Investor During a Bull Market http://yourpfpro.com/everyones-a-great-investor-during-a-bull-market/ http://yourpfpro.com/everyones-a-great-investor-during-a-bull-market/#comments Thu, 20 Jun 2013 00:23:49 +0000 http://yourPFpro.com/?p=2343 We all know the market has been on a tear the past couple years.  The S&P 500 is at an all-time high and I know my 401(k), along with others’, has performed tremendously well.  But my awesome returns aren’t due to the fact that I’m an investing genius, all I’ve done is maintain my portfolio […]

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Everyone's a Great Investor During a Bull Market

Me Looking Tough In Front of The Charging Bull

We all know the market has been on a tear the past couple years.  The S&P 500 is at an all-time high and I know my 401(k), along with others’, has performed tremendously well.  But my awesome returns aren’t due to the fact that I’m an investing genius, all I’ve done is maintain my portfolio with a few low cost index funds and that’s it.  I’m sure there are others who go the opposite route and pick a handful of individual companies and they’ve probably seen awesome returns too.

But is all the money this second group makes due to their extraordinary stock picking talents or is it due to a positive market trend in general?  I tend to believe the latter since any gain is a good gain in most people’s books.  I don’t think the key to investing lies in stock picking, instead I think it’s about being consistent and sticking to your investment plan.  If your asset allocation is 90/10 during good times, it shouldn’t change during bad times.

Don’t get too used to 10%+ annual returns since they could disappear at any time.  Although the market has averaged a 10% annual return since it’s inception there have been years of -20 and even -30% returns.  Now that we’re in a bull market, it’s actually a good time to look at your retirement accounts and re-balance if necessary.  If your AA has skewed toward stocks, then you’re going to want to sell some of those stocks and rebalance with more bonds.

Comparing Your Returns

Even actively managed investment funds are performing well in these times.  But how well depends on what benchmark you compare them to.  Benchmarking is the process of comparing one’s returns to industry standards.  In this case, if I’m investing in a variety of hand-picked stocks like an actively managed fund would, I need to compare the returns to a benchmark like the total market index.

In another scenario, let’s say I’m invested in an S&P 500 index fund through my IRA account and it’s returned 12% YTD.  12% sounds great doesn’t it?  The only problem with that number is that the S&P 500 benchmark has returned 14% this year.  By investing in a Vanguard 500 fund like VFINX(with a low expense ratio) you could have actually exceeded the benchmark’s return.  Discrepancies like this are normally caused by high expense ratios or active managers trying to pick and choose and guessing wrong so be sure you understand what funds you’re invested in.

Stock Picking is For Suckers

If you like to engage in stock picking, where you only invest in a few to a handful of companies, you are taking on uncompensated risk.  One of the core tenets of investing says that if you take on more risk you should be rewarded with higher returns.  That’s why we invest in stocks more heavily than bonds when we’re young.  But by investing in only a few companies, you are increasing your expected risk while your expected return stays the same.  There’s nothing that mathematically indicates you will achieve a higher return by investing in only a few companies.  You can easily eliminate this risk by investing in a diversified fund of companies like an index fund.

The reason why I bring this up is that in a bull market, uncompensated risk is sometimes not as apparent as in a bear market.  Since nearly every stock is trending upwards, no matter what company you select, you’re probably going to make a lot of money so you forget about the risk that you’re taking on.  Once the market turns bear, there’s a higher chance that one of your individual stocks could go bust and devastate your returns accordingly.

I still think a simple three fund portfolio or even a target date fund(with low expense ratios) makes the most sense for 90% of investors.  Investing doesn’t have to be that complicated, but when you start investing in individual companies and employing complex strategies, things can get confusing.  I would never invest in anything I didn’t fully understand since the risk is not worth the reward.

Readers, do you understand the concept of uncompensated risk and why it makes no sense to invest in an individual stock?

-Harry @ PF Pro

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3 Expenses That Will Go Up As You Get Older http://yourpfpro.com/guest-post-3-expenses-that-will-go-up-as-you-get-older/ http://yourpfpro.com/guest-post-3-expenses-that-will-go-up-as-you-get-older/#comments Wed, 05 Jun 2013 20:56:28 +0000 http://yourPFpro.com/?p=2149 This is a guest post by Chris at StumbleForward.  Head over to his blog and check out his other articles after you’re done with this one! We all understand that the cost of living is going up on an annual basis.  But as we get older, there are going to be some huge cost increases […]

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3_Expenses_Go_Up_as_you_get_OlderThis is a guest post by Chris at StumbleForward.  Head over to his blog and check out his other articles after you’re done with this one!

We all understand that the cost of living is going up on an annual basis.  But as we get older, there are going to be some huge cost increases that you may not have realized you had to deal with making those golden years not so golden anymore.

So in this article I’m going to cover 3 expenses that may be increasing and help you plan for those increased expenses now before it’s too late. 

Taxes

One of the first increases you may see is a rise in is taxes.  Once you’ve retired you won’t be able to claim several of the great tax deductions like you once did.  To start, your kids will likely have all grown up and moved on with life so you won’t be claiming any sort of child tax benefit.

Secondly, now that you’re retired you won’t be contributing towards your retirement through a company retirement plan such as a 401k.  Contributions towards these programs helped keep your taxes lower during your working years and what’s worse is when you go to withdraw that money you will owe taxes on every single penny you pull out.

Finally, one of the last ways your taxes will increase is if you are a homeowner, because once you have your home paid off you will no longer be deducting the interest you paid toward your mortgage.  The only upside to this is that you won’t have a mortgage payment anymore.

When it comes down to it, your taxes will increase when you get older assuming your income stays the same.  You may not necessarily jump up in tax brackets but rather you won’t be getting the comfortable deductions you once were.  To avoid these issues now, start contributing toward a retirement plan that is not tax deductible such as a ROTH IRA.  Doing this allows you to pay a portion of your taxes now before you retire and hopefully at a lower rate.

Insurance

The next thing to increase is your insurance, and the big one on this list is health insurance.  Health insurance has been increasing by huge amounts over the last few years.  In fact I’ve personally seen it go up by 50% in the last two years alone.  On top of that in the state of Ohio it is projected to go up by 80% by 2017.

However if you’re on Medicare don’t count yourself safe either.  In a recent article by the New York Times, claims that the Medicare trust fund will run out of money by 2024.  This means the safety net that you once had could be gone now, and before that time even comes you could be seeing a huge decrease in benefits, and higher taxes cover the ever widening gap.

On top of that consider the cost of life insurance.  When you are younger, life insurance is cheap.  But when you hit age 60, rates can go way up and a pre-existing medical condition will make the situation worse. In fact nearly 50% of those living in the US do not have life insurance.

In the end, insurance for the elderly is going up especially as you get older.  Buying life insurance earlier in life when you are healthier and younger could save you a lot.  Secondly, start saving extra for your health insurance needs, by setting up an HSA account or extra savings account to help cover unexpected medical expenses.

Retirement

When it comes to retirement savings, most people don’t start until it’s too late.  In fact, in a recent survey by the Employee Benefit Research Group said that 60% of 55 year olds and older had less than $100,000 saved for retirement.

What’s worse is that the cost of living is also increasing on a year by year basis, which means when you do plan to retire things are going to cost more, a lot more.  Not having this extra cost figured into to your retirement savings may end up draining your savings faster than you anticipated.

Finally, we have to consider social security.  As it stands right now social security may run out by as early as 2023, and just like Medicare, it will likely be facing benefit reductions, and possible tax increases.

The best way to avoid this disaster is to start saving as early as possible.  This will allow you to compound your money for a longer period of time and as a result live a better retirement, not a semi-retirement, or even none at all.

So, what are you doing to protect against these extra cost?

Bio:

This article was written by Chris Holdheide a personal financial blogger with StumbleForward.com, helping people avoid financial mistakes and live a higher quality financial life.

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How Much Should I Contribute to My 401(k)? http://yourpfpro.com/how-much-should-i-contribute-to-my-401k/ http://yourpfpro.com/how-much-should-i-contribute-to-my-401k/#comments Tue, 28 May 2013 17:11:15 +0000 http://yourPFpro.com/?p=2255 Four years ago, I knew very little about saving for retirement.  But I didn’t need to know anything yet, since I had just graduated and I was more worried about getting a job than saving for retirement.  Once I landed that great-paying job though and got my first paycheck, I had to decide how much […]

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Saving_for_Retirement_Contribution_401kFour years ago, I knew very little about saving for retirement.  But I didn’t need to know anything yet, since I had just graduated and I was more worried about getting a job than saving for retirement.  Once I landed that great-paying job though and got my first paycheck, I had to decide how much to contribute to my 401(k).

Saving and investing for retirement isn’t something they teach you about in school(they should though!).  So it’s up to you to independently do your own research and figure out what to do.  I am shocked and sometimes appalled at the lack of knowledge my co-workers have when it comes to investing.  I’m talking about the basics: the difference between a 401(k) and a Roth, the tax treatment of 401(k) contributions, etc.

It’s funny how conscientious people can be about their every day finances but so lackadaisical when it comes to retirement.  People are living longer than ever, things are getting more expensive and taxes are going up.  This all leads to a higher cost of living in the future and the more money we’ll need in retirement.  The current 401(k) system sucks and it doesn’t work for most people because it gives them the option to contribute.  Most people would rather see a larger paycheck today so they tend to contribute less.

I would much prefer a system like Australia’s, where employers are forced to contribute 9% to a Suncorp superannuation fund.  Unlike social security, the money is still yours though.  I prefer this ‘forced contribution’ since it’s kind of like an auto-deduction from your paycheck.  You’re essentially getting the same salary, but 9% of it is automatically siphoned off to your retirement account.  Most of us don’t live in Australia though, so we need to figure out how much to contribute ourselves.

The Bare Minimum

The minimum amount to contribute is usually pretty easy to determine: you’ll want to contribute at least up to your company match.  Pretty obvious right, why would you turn down free money?  I can’t think of one good reason not to contribute up to your company match.

For those who do contribute the minimum, great job but you should probably be contributing more.  Successful people don’t ever become so by doing the bare minimum.  Why would you go through your whole life over-achieving in school, in sports and busting your ass at your job but only contribute the minimum when it comes to retirement?  That baffles me.

So What’s the Right Number?

I’ve thought a lot about this question over the past few years and I’m still trying to find an eloquent way to answer it.  I think a lot of new grads tend to get too accustomed to living off their parents during college and once they’re on their own it’s natural to want that same lifestyle.  All students don’t follow this path. Many will take out loans for undergrad, find a job and work around the pursuit of a flexible setup such as night classes or pursuit of an online mba program.

Most people need to have their ‘investing epiphany’ before they realize the benefits of compounding interest.  Save a lot now so that you can have your money working for you for 40+ years and earning interest that whole time.  I was 22 when I had my ‘epiphany’ and since then, I’ve worked hard to make as much as I could so that I could save as much as I could.

I’m fortunate to have had my epiphany early on and that determination has allowed me to amass a 6 figure retirement portfolio by the tender age of 26.  Go type those numbers into a retirement calculator and maybe you’ll have your ‘investing epiphany’ too.  Too lazy?  Ok, you’d have about a million dollars in your retirement account(assuming a conservative 6% return over 40 years) when you retire at the age of 65.  That’s without ever contributing another dime for the next 40 years.  Reason enough for you to save?

Increase the Contributions

Even though I now max out my 401(k), Roth IRA and HSA it wasn’t always like that.  I started off slow with a 401(k) contribution up to the match but every year I would add 1% to my contribution.  A lot of employers actually have programs that you can sign up for that will automatically increase your 401(k) contribution each year.  Since there are new tax laws going into effect and older ones expiring every year, your paycheck from year to year will always differ, so you shouldn’t even notice a 1 or 2% change.

I’ve talked before about how contributions matter more than performance when you’re young.  And the best way to increase your contributions without affecting your take home pay is to use your raises and merit increases to offset your contribution increases.  I’ve gotten a 2-4% merit increase every year and as soon as I got it, I would always go into my 401(k) and increase my contribution by that exact amount.

I don’t think it’s fair to provide specific guidelines to how much you should contribute to your 401(k) since everyone’s situation is so unique.  One person might have student loans at 6.8% to pay off and another might live in an ultra-expensive city like New York or San Francisco.

I can provide a minimum and a maximum percentage but it’s up to you to determine everything in-between.  If you like the idea of turning $100,000 into $1,000,000 in 40 years without having to do anything other than plopping your money into a basic target retirement fund, maybe you should be closer to the maximum.

Readers, how much do you contribute to your 401(k) each year?  What percentage of your salary is it?

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What Should I Do With My Bond Funds? http://yourpfpro.com/what-should-i-do-with-my-bond-funds/ http://yourpfpro.com/what-should-i-do-with-my-bond-funds/#comments Thu, 11 Apr 2013 05:58:52 +0000 http://yourPFpro.com/?p=2079 Bonds are an essential part of any diversified portfolio.  Although we generally don’t expect the same high returns with bonds as we do with stocks, there is much less risk.  Bond funds can be a great diversification tool since they have low correlation with stock funds.  Essentially, that means that the health of the stock […]

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Bond_Duration_Timeline_What_To_DoBonds are an essential part of any diversified portfolio.  Although we generally don’t expect the same high returns with bonds as we do with stocks, there is much less risk.  Bond funds can be a great diversification tool since they have low correlation with stock funds.  Essentially, that means that the health of the stock market will have little to do with the bond market.  Stocks could be soaring while bonds remain relatively neutral or even negative(and vice versa).

But why would any long term investor want to invest in bonds when the market has returned almost 10% year to date(4/9/2013)?  Since bonds have a low correlation with stocks, they can reduce portfolio volatility without greatly sacrificing returns.  A portfolio of 100% equities should give you the highest return over the long run but who knows how long it will take to achieve those returns.  There have been many 10 year periods of negative stock market return and even a few 20 year periods with low returns.  Sometimes you get lucky by falling into the right window.

I think holding bonds makes a lot of sense since as your potfolio approaches 100% stocks, the “risk-return” profile becomes less efficient.  This chart shows that the returns for a 100/0 portfolio are similar to 80/20 but you take on significant more risk/volatility for a very meager increase in returns.  Since my current investing horizon is 40 years from now, I’m pretty aggressive with my allocation at 90/10 stocks/bonds.  Most bogleheads would recommend an upper limit of 80/20 for an aggressive stock allocation.

How Bond Funds Go Up or Down

You may already know that when interest rates go down, bond funds go up and vice versa, but do you know why?  A bond is essentially an IOU that pays interest at fixed intervals until maturity when you receive the full amount back.  So if you purchase a $1,000 bond with a 2% interest rate and decide to sell it one year later when rates have gone up to 3%, no one is going to pay you the full amount for your bond since they could just go out and buy a newly issued bond at 3%.  This is the interest rate risk component of bonds.

Duration of a Bond

The duration of a bond is the weighted average of times until the fixed cash flows are received.  The duration of a 5 year bond with a 1% coupon rate would be 4.89 years while the duration of a 5 year bond with a 5% coupon rate would be 4.49 years.  Even though they both mature at the same time, the latter has a shorter duration since more interest is paid out prior to maturity.

Bond duration is important because when interest rates rise you can easily calculate your potential losses by multiplying the bond duration by the change in applicable interest rate.  If you own a bond fund with a 5 year duration and there is a sudden 2% increase in interest rates, your fund would lose 10% of its value.  So in today’s low interest rate environment, it doesn’t make much sense to invest in bond funds with medium to high durations since their expected returns are so low.  Vanguard Total Bond Market(VBMFX) for example has a duration of 5.18 years which allows you to be right in the meaty part of the “risk-return” profile.

Must Bond Funds Go Down?

I’ve read a lot of articles from popular media lately about the looming “bond bubble” and how it’s time to get out of bond funds now.  They claim that since interest rates are so low, they have nowhere to go but up.  And since bond funds go down when interest rates go up, it makes sense to sell off your bonds now before it’s too late.  But I see two major problems with this argument.

First, we don’t know when interest rates are going to rise.  Remember that rates don’t have to do anything, the only thing we know for sure is that they cannot go much lower since their is a mathematical bound at 0.  Second, while higher rates can cause short to intermediate term losses, in the long term you are likely to earn higher returns since the new higher rates will eventually offset the losses, and then provide higher returns than if rates had remained low.  So realistically you probably won’t ever see the 10% drop mentioned above, since a 2% interest rate increase will happen over a period of months or maybe even years.

Stocks are NOT a Substitute for Bonds

If you’ve decided that the interest risk on bonds isn’t worth it right now, that’s fine, but your other options aren’t a whole lot better.  Be careful not to chase yield by substituting bonds for stocks.  One popular strategy involves replacing bonds with high dividend stocks since they tend to spit out a consistent 3% yield.  But high dividend stocks have a huge positive correlation to the total stock market.  As you can see in this article by the Oblivious Investor, you lose all of the diversification benefits of bonds when switching to a highly correlated asset like dividend stocks.

There’s not a whole lot of positive news on the bonds front other than to stay patient and stay the course.  Even though bonds won’t be able to mathematically maintain the results of the past 10 years, they provide needed diversification and reduced volatility for your portfolio.  As long as you are invested in short to mid duration bonds, your losses will be softened by the slow moving nature of interest rates and the re-investment at higher rates.

It’s very unlikely that you’ll wake up one day and see a 5% jump in interest rates(and corresponding 25% decrease in your total bond market fund) like what could happen with stocks.  Instead, rates will probably slowly begin to creep up in the future but we won’t know when.

Readers, have you taken a look at the duration of your bond funds lately?  Are you staying the course or chasing yields with dividend stocks or some other investment?

-Harry @ PF Pro

If you’re looking for more resources on bonds, here are some of the books that I recommend(These are amazon affiliate links so if you click and make a purchase I will receive a small commission.  Thanks for supporting the site!)

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