Hello everyone! How are you doing on last week’s Step 1 “estimating your investment goal” assignment?
If you don’t know what I am talking about, click here: https://prepovercoffee.substack.com/p/investing-basics-step-by-step
I know some of you are working on it based on the questions I received and yes, it can be overwhelming, so hang in there. In the spirit of creating community, I thought I would share some of the questions and answers about Step 1 here.
The calculations seemed high for what I would need to retire? Do I really need to save that much?
Most retirement calculations are based on your philosophy about the future. If you watch the news or read any publication on any given day, you will see that the “experts” in investing are all over the board. Some say we are headed for a recession. Others say we are on the cusp of a bull market. The same goes for investing with a longer horizon - everyone has an opinion and none of them are the same.
In addition, the entire philosophy of retirement accounts is based on the fact that these investments grow “tax free” through your working years and only require you to pay taxes after you retire and start withdrawing your funds. Much of their value stems from the belief that after you retire, you will be in a lower tax bracket. However, that may not be the case. For example, what if the tax brackets increase substantially between now and your retirement date? Or, what if you do such a good job creating dividend income (remember what that is?) that you are still in one of the higher brackets after you are no longer collecting a salary? This is why having a strong understanding of the “why” behind your choices and being educated on the environment you are invested in helps to ensure that you address your goals.
As for the amount, what was provided in Investing Basics: Step by Step is just a guideline to help you get started without getting into the level of brain damage needed to estimate the negative impacts of inflation and additional return on investment (or market corrections) over a 25 to 40 year period.
I would say it is a pretty realistic guideline for most, given the most recent US Bureau of Labor and Statistics study illustrating that the average retiree currently spends $52,141 per year. That number will likely grow each year due to inflation and the increasing costs of healthcare and housing. And, since the average household (not retired) spends $61,334, you have to consider what expenses will fall away and what will be added after you retire.
What about all the growth that might happen “during” my retirement years? Doesn’t that count toward my goal?
Estimating your goal is a very general concept. And, the longer your money will sit in the investments you choose, especially as you are retired but not drawing the money out, the more it will grow and thus, the less you might need to have saved on day 1. But, the converse of this is also true. If you are going to start needing the funds in your investment accounts dedicated to retirement right away, you are going to need to start out with more money invested because there will not be as much sitting in the accounts exponentially growing.
I don’t need to save this much if I receive social security, right?
According to the Social Security Administration (SSA), the average monthly retirement benefit for Social Security recipients is $1,781.63. Even Joe and Jill Biden only collect $4,555 per month collectively!
Without the complexity of adjusting for inflation, for a person retiring at 65 and living to 90, this would provide at least $534,000 toward their retirement goals. But, this is another area where you have to decide for yourself what you think will happen. Will Social Security still be solvent? Will the formulas and resulting payments change for people with different levels of savings? No one knows the future, so your best educated guess is all you have.
If you believe that Social Security will be there for you in its current fund, go to the SSA.gov website to calculate your benefit and reduce your savings goal by that amount.
I do not typically advise including this in your early calculations.
I am in debt, shouldn’t I pay that all off before I start saving for retirement?
Short answer, not necessarily.
For interest rates that are higher than 9% (recent rates impacted by inflation, current credit card debt), you may want to pay those down sooner rather than later.
However, there are a few key things that you will miss out on by not saving for retirement right away, even while you are still in debt. For example, if you have debt with a more reasonable interest rate (think 2% - 8%), you will still likely want to allocate some money toward retirement and other long term savings goals.
In these situations, it may make better financial sense to pay less against the debt and more into your longer term investment buckets:
The longer your investment horizon (meaning the longer you put money into the account and leave it untouched), the less you have to save yourself and the more you can rely on returns in your investment accounts.
Your company may offer a 401(k) or other retirement account that lets you put away money before taxes, meaning not only will you have the opportunity to save and have your investments grow tax free, you will save a bit on your tax bill now. Same goes for any deductible IRA contributions. Even better if your company makes matching contributions!
This is another area where you will have to apply your own beliefs about the economy, your financial earning power, and what you feel most comfortable with.
Check out this great article to help you make the decision: Should You Pay Down Debt Before Saving?
And this one, on how to balance both long term investing and debt to your advantage: How to Save for Retirement While Paying Off Debt
I am demoralized now that I see how little I have saved. Should I just give up?
The Rule of 72 is still your friend and should give you comfort that it is better late than never.
If you recall, the Rule of 72 is simply the formula to use for calculating how long it will take for your money to double.
Let’s say your goal is $1 million in retirement savings, but you only have $100,000 saved. If you invest that $100,000 effectively, you could achieve a 10% return or more in some periods. Let’s say we are on the cusp of a bull market, and you achieve a 10% return on your money each year. According to the rule of 72, it will only take 7.2 years to double your money at that rate. In 7 years, your $100,000 could become $200,000. And if you add funds to it, it can grow exponentially. Even at a conservative 5% annual rate of return, it will take approximately 14.4 years for your investment to double. So, even if you are 35 or 40, you could have 25, 30 or even more years to grow your investment balances. 25 years is a long time when you keep your money in place and allow compounding, reinvestment of dividends, and appreciation to help it grow.
As they say at Nike, “just do it.” And, remember Kate Bush and Peter Gabriel when you feel despondent about your financial situation:
I was googling this topic and saw a Rule of 25. Is that different from what you provided?
There are a million formulas out there. The Rule of 25 is just another way of looking at the 4% withdrawal rule. Remember when we did this calculation last week?
By dividing $43,000 by .04 (4%), you show a required balance of $1,075,000.
Dividing by .04 is the same as multiplying by 25. $43,000 x 25 = $1,075,000. Ah, the wonders of math! The concept here is that many people believe that a retirement portfolio can last for at least 30 years if you withdraw 4% the first year, and adjust this amount for inflation each year thereafter. Thus, using this as a foundation for your calculations, you can determine how much you need to save in the first place.
What is FIRE and does this help me reduce the amount I might need in Step 1?
The “financially independent, retire early” (FIRE) movement is based on a 1992 book, Your Money or Your Life. “Proponents of the extreme-saving lifestyle remain in the workforce for several years, saving up to 70% of their yearly income. When their savings reach approximately 30 times their yearly expenses, or roughly $1 million, they may quit their day jobs or retire from work altogether.” They tend to rely on the 4% rule, or a 3% version where they withdraw 3% of their “nest egg” in year 1 and then adjust from there annually (a slightly more conservative version of the 4% rule). But the FIRE approach isn’t for everyone (especially those who did not count on today’s inflation rates or could not achieve the frugality required to save 70% of their annual income to prepare and then continue throughout retirement).
If you want more information on how much you need for retirement, and some other things to consider, check out:
And, stay tuned for next week, when we will move to Step 2, Asset Allocation basics. I promise, if you can shop for hamburger at the grocery store, you can understand portfolio asset allocation. You will be surprised at how much alike these two concepts actually are!
Still have questions? Keep them coming! You can email prepovercoffee@substack.com or post a comment.
ESPRESSO SHOTS
If you are sick of thinking about money and instead want to go watch The American President for the 300th time, you are not alone. And according to Samantha Irby, none of us should be embarrassed about the “basic” things we love, especially when they are judged by our high brow friends. Check out: My Taste is Basic. So What? in Harper’s Bazaar.
It’s an excerpt from her book, Quietly Hostile.
Speaking of Nike, if you have not seen it yet, watch Air, still on Amazon Prime. It’s the story of Air Jordans without having to watch Michael Jordan.
If your more immediate concerns are about running your business so that you can retire at some point, check out Blackberry (the movie), for an A-Z look at what NOT to do. It reminded me of the failures of Betamax (also initially better than VHS) and how much more I loved HD DVD than Blu-ray (hint, HD DVD lost).
All of this reinforces the lesson:
“Those who don't know history are doomed to repeat it.”
― Edmund Burke