Category: Retirement Planning

Goal Planning

Perhaps you’ve never heard of Goal Planning?  It’s actually an ancient concept but an easy one to grasp.  In our case it boils down to this: what boxes do we have to check and what investment performance do we have to achieve in order to retire comfortably?

In my previous article I talked about an investment strategy that I believe should work well for most people.  It’s a very aggressive strategy and not to everyone’s taste.  But, is it really necessary to “set our hair on fire”?  Maybe not.  Perhaps a more modest investment strategy, one with a lot less risk, will achieve our goals. That’s what goal planning will tell us.

If you want to retire to a 10,000 square foot waterfront  house in Malibu, CA then you’re going to need a lot more money than someone who just wants to putter around the house and visit the grandkids once a month.  Not everyone’s idea of retirement is the same.  Some people have no concept of what their life in retirement will look like.  Let’s take a crack at our checklist.

1. What do you want to do in retirement?  It’s no accident that this question is first because everything you do will depend on the answer.  Don’t know?  Guess!  If you really don’t know it’s best to assume that you will continue your current lifestyle.  You can always change your answer later, but in order to proceed you’ll have to have some “goal” to work towards.
2. Create a budget that represents your expenses today.  This sounds easy.  Everyone knows what they spend on fixed expenses like mortgage, electricity, phone, etc., but many people don’t realize what they spend on variable groceries, restaurants, gas for the car, etc.  You may be surprised.  When I first started tracking my expenses I was shocked at some of the things I saw!
3. Create a budget for your life in retirement.  There’s some advice on how to do that below.
4. Create a financial projection.  This will tell you how much money you should expect to have in the future.
5. Create a budget for your current life that will allow you to achieve your goals.

Now we’ve come to the hard part.  Until this point you’ve been a passive reader; now you become an active participant.

Let’s assume you’ve decided what you want do once you retire.  Congratulations,  you have some goal to work towards.  Next, let’s make a budget of our current expenses.  Why?  First, you may want to keep your current lifestyle in retirement and this will give you some idea of what monies you’ll need.  Second, assuming you will have a different lifestyle in retirement, your current expenses will give you some sort of jumping off point for creating a new budget.  Let’s look at our sample budget.

Note: This budget is completely fictitious and is unlikely to reflect your lifestyle/expenses; in order to get something out of this exercise you’ll have to enter real numbers and real categories and get realistic numbers.

The thing you should notice is that is doesn’t include any savings.  That’s because savings is what we’re trying to solve for.  Now let’s assume that we’re going to keep this general lifestyle when we retire.  Let’s make a similar budget and eliminate all of the things that will no longer be necessary (also shown on the sample budget).

When we compare our retirement expenses with our current expenses we notice that the value dropped by approximately 40%.  Why?  Well, the kids are out of the house, no more college expenses, the mortgage is paid off, you no longer have a high income so your taxes are reduced, and so forth.   If you don’t want to make a detailed retirement budget just take 60% of your current budget and you should be in the ballpark.

Note: All dollar figures are in “today’s” money.  We’ll include inflation in our financial projection.

Creating a financial projection is a difficult thing to do.  Predicting the future is hard and there are many different methodologies for trying to do so.  For our purposes I will show a plan that uses linear projections.  I like this methodology because it’s simple and as likely to give a good long term estimate as any other methodology.

The model shown illustrates the following…

• A couple, both of whom are 30 years old
• They will both retire in 37 years at age 67
• They have no retirement savings at present
• They will save $24,000 per year
• Their retirement expenses will be  $64,000 per year
• Their portfolio will make about 6% year over year
• The rate of inflation is 2.5% per year over year
• Their combined social security is $58,800 per year at age 67
• Their social security is adjusted upwards by 0.5% each year
• At age 80 Social Security income for person 1 is dropped (someone dies)

The model (PDF version or Excel version) shows that the portfolio balance peaks at around age 67 at just under 2.3 million dollars and there is enough money to last until age 91.  The model has a fudge factor that automatically makes it a little more conservative than straight math would.  Interestingly the future value of $64,000 (the expenses) at age 67 is about $160,000.  Wow!

Of course, in order for these numbers to be meaningful for you, you have to plug in your own values.  The spreadsheet contains two tabs: one is assumptions and the other is calculations.  If you don’t like the results you got jigger the numbers until you do.  Just remember to keep your assumptions realistic or else the model will be meaningless.

You can easily get your projected social security values from The United States Social Security Administration.

Now, go back and play with all of your budgets and plug in new values into the model and see what makes sense for you.  These are all meant to be living documents and, if I were you, I would update them all about once a year.  That’ll give you a good idea of where you stand.  I wish you well!

That should wrap up our series on retirement planning.  I hope you enjoyed reading about it as much as I enjoyed writing about it.  If it helps you, so much the better.  Feel free to ask questions, I love to see people succeed.

(This will be the last time I will say this –  I am not a professional financial planner.  This article is meant only for illustrative purposes.  You should check with your own financial advisor before embarking on any retirement plan.)

Investment Strategy 

Traditional investment strategies typically look something like this: invest 60% of your money in equities and 40% in fixed income using a wide range of mutual funds.  Using this strategy your portfolio will be somewhat well diversified, not too volatile, will have less than average gains and will make your advisor/fund provider a lot of money.

How about a portfolio consisting entirely of stocks?  Equities have great long term performance, they’re cheap and easy to buy and sell and they have no expenses of any kind.  On the down side they are rather volatile and a portfolio consisting only of equities would not be well diversified.  Besides, who has the time and expertise to choose individual stocks and manage such a portfolio?  Let’s try to address these shortcomings.

Volatility: How can we prevent this?  We can’t!  What we can do is realize that investing for retirement is a long term proposition and in that context volatility isn’t really a big issue.  Yes, on a month-to-month basis your portfolio value will swing like a tree in a hurricane but if you look at your portfolio in five year intervals the only thing you’re likely to see is more money.

Diversity: What is the purpose of diversity?  Its main use is to lower volatility.  We just decided that volatility wasn’t really an issue so there’s no need to worry about diversity.

Time and Expertise: Instead of purchasing stocks outright let’s buy an index fund.  The index defines what stocks we are buying so there’s no time consuming research or maintenance.  All we have to do is pick the right index fund.

Index funds are conceptually similar to mutual funds.  The performance of the fund is designed to match the performance of the index it is tracking.  With index funds there’s rarely a transaction fee to purchases and sales, the expense charges are very low and they normally don’t have 12B-1 fees.  They’re as close to free as you’re going to get.  Never heard of index funds before?  Not likely.  I’ll bet you’ve seen commercials on TV for “Spider” funds for years.  Well, Spider is just a brand name; it’s like saying “Kleenex” instead of “tissues”.  Index funds have been around for years and they’re available from just about any brokerage.

That leaves just one problem: what index fund should we buy?  How about The Standard and Poor’s 500 index or S&P 500?

The S&P 500 is the gold standard by which all other investments are measured.  Whenever anyone talks about how their portfolio performed they speak about it relative to the performance of the S&P 500.  Professional money managers spend their careers trying to figure out how to best the S&P 500 year after year.  Very few succeed.  While it may not be possible for us mortals to beat the performance of the S&P we can match it without any effort at all.

So, what kind of returns can you expect?  I’ve prepared a data sheet (click here) that shows the performance of the S&P 500 since its inception in 1928.  There are several things worth noting…

1. The index has been VERY volatile
2. Since 1928 it has returned an average of 11.42% each year
3. In the past 30 years its ranged from a high of 37.20% to a low of -36.55%
4. In the past 15 years the average return was 8.28%
5. In the past 30 years the average return was 11.51%

In summary, if you’re investing for the long term, want a good return on your money, don’t want to pay high fees and don’t want to spend a lot of time managing your portfolio investing in an S&P 500 index fund might just be a good way to go.  If you have any questions or need more information please don’t hesitate to contact me.

Next up, let’s talk about goal planning.

(How many times can I say this –  I am not a professional financial planner.  This article is meant only for illustrative purposes.  You should check with your own financial advisor before embarking on any retirement plan.)

Financial Advisors

There are several kinds of financial advisors.  If you have a million dollars or more you can get “Private Wealth” services from your bank, “Private Wealth Management” firms to pay attention to you, engage with various types of hedge funds or even explore specialty investment firms.  In short, you wouldn’t need to be reading my little blog for advice.

If your funds are a tad more modest then there are basically two services of which you can avail yourself of: Personal Financial Consultant and Investment Manager; those are my terms as I don’t think there are any industry standard terms for them.  If you’re not comfortable managing your own money then perhaps a financial advisor is the way to go.

Let’s talk about references, bona-fides and responsibilities.

If you’re lucky enough to have a friend or colleague  that you trust who is happy with their advisor then by all means explore that opportunity.  Not all advisors are appropriate (or appeal) to all people but that’s a really good place to start.  If you’re not lucky enough to get a referral, or a referral that worked for you, then you should interview several advisors and see which one you feel will be most appropriate.  Before you engage any advisor require them to give you references.  You may have to press them on this point as they may be hesitant to disclose their customers or they may refuse outright.  If you can’t get them to give you any references then you should seek advice elsewhere.

Next, your advisor should be accredited.  The most prestigious certification is “Charted Financial Analyst” or CFA; most of them will have this.  If not, make sure that they have some other, well recognized or appropriate certification.  Don’t be afraid to look them up in their organization and confirm their credentials and/or any complaints against them.

Lastly, let’s talk about responsibilities.  The keyword here is Fiduciary. Financial advisors are not always required to act in your best interests. You may find yourself in a situation where they must act in your best interests for part of your portfolio (perhaps retirement accounts) but not all of it (perhaps college savings accounts).

If you read that last paragraph and are shocked and horrified then you understood it correctly!

Make sure you have a conversation with any prospective advisor about their Fiduciary responsibilities.  If they say that they act as a Fiduciary then that statement will also appear somewhere in their firm’s literature; make sure that it does.  If they tell you that they are not a Fiduciary but that it is merely a technical distinction or that it is actually better because it gives them more freedom, or some other such nonsense you should run, Run, RUN as fast as you can and never look back.  Why would you invest with someone you can’t trust?

Personal Financial Consultant

Personal Financial Consultants usually offers a large array of services such as wills, living wills, powers of attorney, trusts, insurance, estate planning, tax services and, of course, financial planning.  They charge a fee for their services. They never invest your money directly.  They will give you recommendations and expect you to execute the appropriate orders in your own account with your own brokerage.  That way there is no conflict of interest.  Typically you will wind up with a large number of mutual funds that will give you exposure to a number of different asset classes and provide some form of diversity.

There is normally a substantial fee for the initial set of consultations and after that a smaller fee for periodic follow up visits (annual and semi-annual are common).

Investment Manager

Investment Managers usually offer fewer services than Personal Financial Consultants.  They normally concentrate on the investment portion of your portfolio. You don’t pay them directly; they get paid from the companies and funds that they represent based on the amount of money that you invest.

Typically you will wind up with a large number of mutual funds that will give you exposure to a number of different asset classes and provide some form of diversity.  If they invest your money in low cost funds, like index funds (we’ll talk about them later), they will charge you a fee of around 1% – 1.5%.  Hey, they’re not doing this for free; someone’s gotta foot the bill and it’s going to be you!

In the case of both the Personal Financial Consultant and the Investment Manager you typically wind up with mutual funds.  With modest sums of money to invest mutual funds can give you exposure to many different asset classes and provide some measure of diversity.  If, however, you read my previous articles on Retirement Planning you will know that mutual funds have their downside too; namely their costs and the associated affect on your portfolio.

Next up, let’s talk about a modern investment strategy that is low cost, easy to implement, requires little/no financial expertise and will give you good return on your investment.

(It’s really true;  I am not a professional financial planner.  This article is meant only for illustrative purposes.  You should check with your own financial advisor before embarking on any retirement plan.)

Investing Strategies

Why do we want to invest our money in the Stock Market (Wall Street).  The answer is simple: over a long period of time the stock market will appreciate more than just about any other type of investment you can think of. Generally speaking the stock market includes stocks (equities), bonds (fixed income), commodities (gold, pork bellies, currencies), real estate (mortgages, REITs) and so much more.  If it sounds complicated it’s because it is!  I will try to help you through all of that.

Let’s say you don’t know much about the stock market or have well founded fears about losing your money.  What’s the alternative?  Your main options are savings accounts, certificates of deposit (CDs) or government savings bonds.  With those, if you’re fortunate, you’ll get a return of about 1%.  Unfortunately for you the current rate of inflation is about 2%.  Putting your money in those instruments is a losing proposition.  You really have little choice but to invest in the stock market.

Mutual Funds

Who hasn’t invested in mutual funds?  I think just about everyone I know had some money in Fidelity’s Magellan Fund at one point; I certainly did.  Common wisdom says that if you have less than a million dollars you should buy mutual funds.  They’re a cheap and easy way to get a professionally managed, diversified portfolio.  The mutual fund industry has done a lot to encourage just that kind of thinking.  As always, the devil is in the details.

If you invest in mutual funds you probably know about ‘A’ and ‘C’ shares.  With ‘A’ shares you pay a percentage of the amount you invest right up front in the form of a fee (typically between 3% and 5%).  ‘C’ shares have no up front fee.  What you may not know is that there is an ongoing expense that you pay for this fund.  You pay a higher expense for ‘C’ shares but there is still a substantial fee for ‘A’ shares.  This expense never goes away; you pay it year after year after year.  There is another even lesser known fee called the 12B-1.  This fee is usually a much smaller amount but you will have to pay it year after year as well.  I like to call small, hidden charges like that, “graft and corruption”.

Ongoing fees for ‘A’ shares are typically in the 1% range.  For ‘C’ shares they are typically in the 1.75% range.  12B-1 fees are less than 0.25%.  Note: For many 401K accounts and high net worth individuals there are often (but not always) ‘K’ or ‘X’ class shares that have much lower expenses.

I have created a simple model (click here) that shows if you invested $10,000 for 20 years and accounted for all of the fees and expenses you would have the following…

• C-Shares: $25,834.32 (an increase of 258%)
• A-Shares: $28,886.10 (an increase of 289%)
• No Expenses: $38,696.84(an increase of 387%)

Note: When considering performance of any investment you should always look at the percentages.  Using dollars amounts for comparison is often misleading.

Because we took 4% right off of the top of the A shares the principle amount we started with was smaller but because the expenses were also smaller the amount grew much faster.  This illustration shows that A shares will outperform C shares if the investment is kept for at least five years.  Even after 20 years the difference between the two is significant but not huge.  Those expenses really weigh on the portfolio’s performance.

The illustration with no expenses outperformed the better performing A shares by almost 100% – a very substantial margin.  Yeah, but is it possible to pay nothing for your investments?  Of course not, but I can show you a way to pay only 0.03% (that’s not three cents on the dollar, that’s three hundredths of a cent on the dollar).  That’s about as close to nothing as you’re going to get.

Next up, let’s talk about financial advisory services.

(Remember: I am not a professional financial planner.  This article is meant only for illustrative purposes.  You should check with your own financial advisor before embarking on any retirement plan.)

How were we able to retire at a relatively early age and still be able to afford to travel full time?  Many people have asked us that very question.  I’m going to do my best to tell you how I think about that subject and convey some of the techniques that we used to get us where we are. Don’t think that you’ll be able to put your head in the sand just because you contribute to your 401K.  Retirement planning means creating a multifaceted roadmap that includes budgeting, savings (pre and post tax), investment strategies and goal planning.

Will the plan be static: No.  Will real life get in the way and cause you to make changes: Yes.  Will this be a frustrating process: Most likely.  What’s most important is to keep one eye on your goals and the rest will work itself out.

Before we can discuss how the pieces all fit together to make an integrated plan we should make sure we fully understand the components of the plan.  Let’s start with retirement accounts; that’s an easy concept to get our heads around.

Retirement Accounts

First off, and I’m sure you’ve heard this more than once before, you should always max out your retirement accounts.  I don’t care how tight your budget is, if you neglect your retirement accounts you are neglecting your future.  You didn’t think you were going to live comfortably only on Social Security did you?  In most cases, with the exception of the ROTH IRA, the monies saved are all “pre-tax”.  What exactly does this mean?

Let me show you a simple example: let’s assume that you’re in the 25% tax bracket and that your gross income on your federal tax form is about $90,000.  That means you’re paying about $22,500 in taxes. Ouch!  If you had put the maximum of $18,000 into your 401K your gross income falls to $72,000 and your tax bill would be $18,000.  That’s a savings of $4,500; that means that you just received a government subsidy – and you thought that those were only for the poor!  In fact that $18,000 only cost you $13,500.  Looked at another way: your retirement account just had a 20% sale!  But, like the infomercial you’re so tired of, it just keeps getting better and better.  Your investments on that money will grow free of interest, dividends and capital gains.

Didn’t think it could get any better than that? You were wrong!  If you’re filing jointly each person can contribute up to $18,000 to their 401K: this translates into a new gross income of $54,000 and a new tax bill of just $13,500.  That’s a total tax savings of $9,000, or a 40% reduction in your original tax bill.  I’ll say that again, you just saved 40% on your taxes!!!

Of course $18,000/$36,000 is a lot of money to sock away each year but who deserves it more than you?  Think of it this way: would you rather pay that money to the government or would you rather pay it to yourself?  Enough said.

Also, many people work at companies that match a percentage of their 401K contributions up to a certain maximum (typically 3%).  This is free money; it’s almost like robbing a bank, but legal.  In order to get this free money you’ll have to contribute to your 401K.  You won’t be sorry.

So, you’ve sacrificed and maxed our your retirement savings.  Think that everything is going to be peaches and cream in your retirement?  Probably not.  There’s a lot more hard work ahead.

(I am not a professional financial planner.  This article is meant only for illustrative purposes.  You should check with your own financial advisor before embarking on any retirement plan.)