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Investing and Economics Blog

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Spending Guidelines in Retirement

Retirement planning is a huge financial need and one of the areas where financial literacy can pay off very well. Understanding the incredible power of compound interest can be used to start your retirement savings early and provide you with a huge benefit. Understanding the risks of inflation can guide your investment decisions. The recent Business Week Retirement Guide is very good. In Spending Safely, they explore how to spend while preserving your capital in retirement.

For more than a decade, financial advisers have warned retirees that draining over 4% of their nest eggs in their inaugural retirement year could ultimately lead to financial ruin.
…
Bengen now suggests that the 4% figure - actually 4.1% for a 60/40 portfolio of large caps and bonds and 4.5% if you toss in small caps - merely seems impressive when plugged into Excel (MSFT) spreadsheets. In practice, the strategy, which Bengen stopped using with his own clients about three years ago, is inflexible and unrealistic he says - and the formula is too stingy.
…
Flexibility is factored into Bengen’s revised approach, which permits withdrawals to fluctuate within guidelines. His “floor-and-ceiling strategy” suggests that an initial withdrawal rate of 5.16% would be appropriate if a retiree pares back subsequent withdrawals by as much as 10% of the initial withdrawal during hard times (the floor). On the other hand, a retiree could withdraw extra cash equaling up to 25% of the first-year withdrawal (the ceiling) when the market is strong.

This adjusted thinking is correct I believe. People want simpler answers but some things just require a more complex understanding.

Related: How Much Retirement Income? - Add to Your Roth IRA - Retirement Tips from TIAA CREF - Our Only Hope: Retiring Later

July 30th, 2008 by John Hunter | 1 Comment | Tags: Personal finance, Retirement, Saving, Tips, quote

Save Some of Each Raise

Failing to save is a huge problem in the USA. Spending money you don’t have (taking on personal debt) and not even having emergency savings and retirement savings lead to failed financial futures. Even though those in the USA today are among the richest people ever to live many still seem to have trouble saving. Here is a simple tip to improve that result for yourself.

Anytime you get a raise split the raise between savings, paying off debt (if you have any non-mortgage debt), and increasing the amount you have to spend. I think too many people think financial success is much more complicated than it is. Doing simple things like this (and some of the other things, mentioned in this blog) will help most people do much better than they have been doing.

There are lots of ways to spend money. And many people find ways to spend all or more than all (credit card debt, personal loans…) they have which are sure ways to a failed financial future. So anytime you get a raise (a promotion, new job…) take a portion of that extra money and put it toward your financial future. The proportion can very but I would aim for at least 50% if you have any non-mortgage debt, don’t have a 6 month emergency fund, or are behind in saving for retirement, a house…

Exactly how you calculate if you are behind, I will address in a future post (or you can look around for more information). By taking this fairly simple action you will be setting yourself up for a successful financial future instead of finding yourself falling behind, as so many do. And then when things go badly, as they most likely will sometime during your life, you will have built up a financial position to draw on. Instead of, as so many do now, find that you were living beyond your means when things were going well - which it doesn’t take a genius to see will lead to serious problems when things take a turn for the worse.

So lets say you take a new job and get a raise of $4,000 a year. Instead of spending $4,000 more just put $2,000 away (pay off debt, add to your retirement savings, add to savings for a house, add to your emergency fund…). Then you get a promotion of another $3,000, increase your spending by $1,500 and save the rest. It is such a simple idea and just doing this you can find yourself in the top few percent of those making smart financial decisions. And if you get to the point that you are ahead in all your financial areas then you can take more of each raise you get (but most of the time you will have learned how valuable the extra saving are and figured out the extra toys really are not worth it). But if you want to, once you have created a successful financial life, you can choose to buy more toys.

Related: Retirement Savings Survey Results - Earn more, spend more, want more

July 7th, 2008 by John Hunter | 2 Comments | Tags: Financial Literacy, Personal finance, Popular, Saving, Tips, quote

New Graduates Should Live Frugally

Graduates should put off living large after college

Good habits are important to start early,” said Laura Tarbox, founder of Tarbox Group, a financial planning firm in Newport Beach. “Take your finances as seriously as you do your relationship and career decisions, and you’ll end up way ahead of everybody else. But you’ve got to do it now. If you start even five years later, it just doesn’t work.”

The key, experts say, is a simple one: Live like a poor college student for a couple more years. While you’re doing that, you can pay off your debt, start a savings plan and embrace healthy habits that will serve you well for life.

This is exactly what I did. Outside of paying for college, extra living expenses in college were small. Just retaining the spending habit of college gets your personal finances off on a good start.

Sallie Smart, 22, economizes like crazy in her first years after school so that she can save $500 a month in her 401(k), and she keeps that pace up indefinitely. Her employer matches 50%, pitching in $250 a month. If she earns a 9% annual return on her investments, when she wants to retire at age 65 she’ll have $4.1 million in her nest egg.

Patty Procrastinator lives a little better when she first gets out of college and doesn’t start saving in the 401(k) until she’s 32. From that point, she also saves $500 a month, her employer adds $250 a month, and she earns a 9% return — just like Sallie. But at age 65, Patty will have only $1.7 million. That decade of delay will cost Patty $2.4 million.

Incidentally, Sallie contributes from her own money just $60,000 more than Patty does. The rest of the difference comes from employer contributions and investment returns.

By immediately starting to save for retirement and other needs you create a great foundation for your finances. Start saving for a house, a new car, create an emergency fund… Then you can create a situation where the only loans you need to take are for a house and maybe a new car - avoiding credit card debt or other personal loans.

Related: Personal Finance Basics: Health Insurance - Initial Retirement Account Allocations - Why Americans Are Going Broke

June 8th, 2008 by John Hunter | 1 Comment | Tags: Personal finance, Retirement, Saving, Tips

Uncertain Economic Times

So lets say you have a 401(k) and are adding to it regularly, you own your house, you have no credit card debts, you are paying off your car loan and overall your financial house is in fairly good order. Still you keep hearing the news about credit crisis, mortgage meltdown, dollar depreciation… It is enough to make you nervous but what should you do?

Frankly very little in the macro economy has much impact on what is a smart long term strategy. Should you move your retirement money into a money market fund, because of the risks of stocks now? No. If you are good enough to time the market you are already amazingly rich (or will be soon). But either no one is able to do this or next to no one is. Occasionally you might get lucky and time things right but being able to consistently do so over 40 years is just not something that happens.

So what you should do now is what you should always do. Have cash savings. Pay off your mortgage (don’t over-leverage yourself - don’t take out equity just because you have some). Save for retirement. Have health insurance. Don’t take on credit card debt (or most other debt). Keep up your employment skills (learn new skills…). Diversify your investments (stocks, international stocks, real estate, cash…).

People often get careless when the overall economy is good. And so maybe you failed to do what you should have been doing then. But the right thing to do today is essentially the right thing to do always. For example, Americans are drowning in debt. They were also drowning in debt 3 years ago. That problem is the same. If you have too much debt you should fix that. Not because of all the fear today, but because to much debt is always bad. You should not take out too much debt in the first place and if you have to much you should fix it whether the economy is strong or weak.
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March 20th, 2008 by John Hunter | Leave a Comment | Tags: Financial Literacy, Investing, Personal finance, Saving, Tips, quote

Create Your Cash Reserve

Some people think all financial info is boring. I actually find a good deal of it interesting but this tip is pretty boring. Building a cash safety net is an important part of your personal finances. We have explained previously the very simple idea that you don’t buy what you can’t pay for. If you can’t pay for it this month, don’t buy it.

But that leaves out one thing. Even if you do have the cash you should be building up a cash reserve before buying luxuries. The typical advice is to build up 6 months of expenses in cash (rent or mortgage, food bills, utilities, health care, etc.). Now actually building up to that level can take awhile and forgoing all non-mandatory expenses until you have that saved is not usually reasonable. But as part of your personal finances building up an cash reserve is important (even if it is boring).

A significant portion of downward spirals in personal finances are started when people have emergency expenses and have to borrow that money (since they don’t have cash reserves). If you are over say 26 and don’t have a cash reserve yet saving for it should be part of your monthly budget. How quickly you build that up is a personal decision but I would say a 1% of the target amount (so if you are aiming for a cash reserve of $20,000 then $200/month).

If your finances don’t allow that, then do what you can. But realize that is one of the weaknesses in your personal finances and try to fix that as soon as possible.

Very important personal financial allocations for you to put first include: current needs (food, car payment, rent/mortgage, utilities…), insurance, creating a cash reserve, retirement savings, saving for future purchases. Then there are luxuries and treats, such as: eating out, vacations, cable TV… Many people put current needs, luxuries and treats fist and then say they don’t have the ability to do what is responsible. That is not often true for those that actually have an internet connection to read this blog.

Related: Buy less stuff - Saving for Retirement - How to Use Your Credit Card Responsibly - Trying to Keep up with the Jones

March 12th, 2008 by John Hunter | 5 Comments | Tags: Personal finance, Saving, Tips

Retirement Savings Survey Results

Have less than $25K in savings? Get in line

Nearly half of all workers saving for retirement have savings that fall short of the $25,000 mark, according to the 2007 Retirement Confidence Survey by the Employee Benefit Research Institute and Matthew Greenwald & Associates. Predictably, the youngest workers (ages 25-34) dominate this group - 68 percent of them have less than $25,000 earmarked for their later years. But so do half of workers age 35 to 44 and a third of workers age 45 to 55 and over.

What is a very rough estimate of what you need? Well obviously factors like a pension, social security payments, age at retirement, home ownership, health insurance, marital status… make a huge difference in the total amount needed. But something in the neighborhood of 10-25 times your desired retirement income is in the ballpark of what most experts recommend. So if you want $50,000 in income you need $500,000 - $1,250,000. Obviously that is difficult to save over a short period of time. The key to retirement saving is consistent, long term commitment to saving.

Related: Saving for Retirement - Start Young with 401k and Roth IRA - Retirement Delayed: Working Longer

April 11th, 2007 by John Hunter | 6 Comments | Tags: Retirement, Saving, quote

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