Don Jones

Tech | Career | Musings

Gregg asks:

I’m in my early 30s, and I need to be doing better about saving for retirement. I’ve overheard you at the bar at PowerShell Summit talking about this – what do you know?

I hope you’ll ask a question, too! And I hope you’ll stick with me here, because this is gonna be a long one. And here’s the list of everything asked so far.

Fortunately, not much, which I think is helpful. Let me preface this by saying that this is entirely about investment planning for retirement, not other purposes. And that these are very much my opinions on the subject, not indisputable facts. But I’ve researched this to an insane level. Also, none of this applies outside the US.

I follow the Warren Buffet plan:

My advice … could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s [VFINX].) I believe the … long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers.

I add a term life policy to that. The policy is decent-sized, intended to take care of things like paying off mortgages, debts, and so on. I also set aside money for final expenses, which I expect to occur after the term life policy has lapsed; I only buy that term until my anticipated retirement age, at which point I expect to have my major life expenses dealt with. Because I’ve been independent for much of my life, I also carry a long-term disability policy, since most financial ruin is caused by medical problems that result in an inability to work. The policy is not cheap, and I hope I’ll never use it, but if I do, it will be worth a million times its price. Quite literally.

I use Vanguard’s Personal Advisor Services, which are ridiculously cheap (.3% fee, versus the usual 1%+, and their fee includes load and trade fees if you use Vanguard funds, which I prefer). Much of the money is, in fact, in VFINX, because I’m a huge believer in the long-term gaining power of the S&P500. I have certain accounts (like IRAs) I diversify a bit, at my advisor’s advice, and a lot of that actually is in government bonds (tax-free ones, and usually state and local governments, not the Fed). We rebalance the investments annually to keep the portfolio mix that I’m happy with. And it’s not a complex one. I can probably pull it up if you’re interested.

Many financial advisors (including ones of past acquaintance) will try and stuff you into incredibly complex portfolios of hedge funds, which they refer to as “actively managed.” My former advisor had us in, like, dozens of them. We did not do well, even as the economy turned up. This is because hedge funds always lose. Buffet proved it (even more so in that only one hedge fund manager took him up on the bet – they all know they can’t beat the market long-term). You might think that a fund with someone huddled over it every day, making minute changes as needed, would do better. That’s how they sell it to you. You’d be wrong. Nothing outperforms the market over decades.

The trick with any of this is, as you approach retirement, to start shifting assets into less-risky holdings, like bonds and less-risky stocks, and you should be largely all-cash by the time you retire. A planner can help you with the timeframes on that based on your age and expectations, but that way a close-to-retirement market crash won’t wipe you out exactly when you need the money. This is the mistake everyone made during the 2008 econopocalypse. The shifting can be complex; for example, you might decide to shift near-term-need money (5-6 years worth) into cash, while moving the rest into more moderate-growth investments, and continuing to shift as you go. That way, your whole investment can continue to earn to offset unforeseen rises in costs.

You also need to think about how much to save, and I assure you that the amount you’re allowed to stuff into a 401(k) probably ain’t enough. The 401(k) was the biggest lie ever sold to the American people. You’re supposed to put ~$68k a year into those things, but most of it is supposed to come from your employer, which means they’d have to be matching 3x or more your contribution, not the fraction they likely are. You, personally, can only put about a quarter of the 401(k) max amount in; if your employer isn’t making up the rest, you’re just out of luck. But 401(k)s were designed to get corporations out from under burdensome pension plans, and nothing in the law requires them to help you fund your retirement.

(As an aside, there’s an equivalent instrument for self-employed people called a SEP-IRA, which lets you contribute 25% of your self-employed income, up to the same annual limit as a 401(k), since you’re acting as both employer and employee.)

Fun fact: a fully-funded 401(k), at $68k annually or whatever the limit is (again presuming both you and your employer are maxing it out), nets $73.7M after 35 years in a 5% market (which would be a low market return). Compound interest is magical. So you can get by with a less-than-fully-loaded 401(k) if you’ve got time on your hands. But this illustrates the critical importance of starting early, even if you can only save a couple of hundred bucks. Compound interest also works against you, which is why we all need to cut back on the credit cards. It’s why, if your mortgage is at something like 3-4%, you’re better putting money into the market than making extra principal payments. The market will tend to outperform your mortgage by 4-5% over time. In other words, it’s better to make 8% and spend 3-4% of it than to avoid paying the 3-4%. Weird, but it’s how math works. Talk to a financial planner. A good one. Who’s paid on fees, not commissions.

Anyway. Back to the retirement budget.

Figure out what you expect your retirement budget to be. Assume a 3% cost of living increase annually, and exclude things you expect to be paid off, like your house. So, let’s say my budget is $5,000 a month after taxes. That’s $60k a year, and I’ll add 15% tax to that for about $70k. It’ll be 3% more expensive every year due to inflation and cost of living raises. I’ll assume I retire at 65 and live to 85, so that’s 20 years I need to account for. $70k times 20 is $1.4M; I’ll show you a trick in a second for dealing with the cost of living adjustment.

So my savings goal is $1.4M. I head to my calculator website.

  • I enter 1,400,000 for my goal
  • I enter 0 as my start
  • If I’m currently 30, I enter 35 years as my savings period (age 30 to age 65)
  • I enter 5% interest. This is because the market, over long periods of time, tends to return about 8%. I deduct 3% to pay for cost of living increases.

It tells me I need to save about $1300 a month. Honestly, that’s about what you can stuff in a 401(k) right now, but I’m guessing $60k/year is actually less than you need, so you’ll need to do the math.

The extra money (once a 401(k) is full) can go into things like IRAs as tax-deferred income, HSAs (if you have a HDHP), or whatever you have access to. Once you run out of tax-avoidance options, you put the money in a brokerage account. Religiously. And you never touch it. Compound interest only works if you don’t touch the money.

Ideas for that budget:

  • Utilities (at today’s rates; the 3% COLA should handle increases)
  • Car payment (you’ll probably still need a car; factor in the cost of a new one so you’re always on warranty and don’t need to worry about unexpected repairs, if that’s easier)
  • Some vacation money
  • Groceries (again at today’s rates)
  • A house-repair fund’s monthly contribution
  • Some amount for Medicare supplemental insurance; God knows how this’ll pan out over 35 years but you can adjust as the situation changes.
  • Property taxes

Stuff like that. Use your current expenses as a guideline, just deduct things you can reasonably expect to be (a) paid off and (b) durable, which basically means your mortgage(s). If you’ve got kids, you can eliminate their insane level of expenses. Just be clear that they’re expected to fend for themselves, and mean it, because I’ve seen that drive more than a couple of friends and relatives into the financial pit.

If you don’t have a handle on where you spend your money today, then you are doomed. Figure that shit out. Those lattes at Starbucks add up, as does the damn “One-Click” button on Amazon. Get hold of your discretionary spending right now so you at least know where it’s going and what can or cannot be eliminated from your retirement budget.

A lot of unscrupulous financial planners – ones who are paid on commissions – will try and sell you complex life insurance products, like Variable Universal Life, as a retirement plan. Others will come at you with “zero tax” schemes, playing on your fear that taxes will “only ever go up, right?” Wrong. People who say income taxes only ever go up are liars. Look at the chart near the bottom of this page. Or look at these, which look at more than just the top rates. Taxes tend to go down. That’s because the economy tends to go up, and the population tends to go up, creating more taxpayers. It may not feel like it when politicians are after your vote, but don’t let the lie scare you into a stupid financial plan.

Warren Buffet is not a stupid man. The market may let you down – there are no guarantees in life unless you pay mightily for them (which is what annuities are for, and they’re incredibly expensive as a result), but if the market fails that completely, over that long a period of time, brother, you have got bigger problems. Like, where to hide from the zombies.

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