In August the financial advisors at Ruedi Wealth Management wrote 5 more “Finance 101” columns for The News-Gazette’s Business Extra section. Make sure to look for them every Sunday, but in case you missed the columns from August all five are below.
Is Saving 10% of Your Income Enough?
Paul R. Ruedi, CFP®
I am often asked what I think a “good” savings rate is. In my experience, most people think if they are saving 10%, they are saving a responsible amount. But is 10% enough? Today I want to work through a simple example to find out.
Suppose a person makes $50,000 per year and wants to replace 80% of that income in retirement. To provide this $40,000, they decide to accumulate a $1,000,000 portfolio and withdraw 4% per year. This person has chosen to invest in a 100% stock portfolio leading up to retirement that returns 9% compounded annually (slightly less than the historical average return of the S&P 500).
Saving 10% of salary each year, ($5,000) it would take that person 33.7 years to reach the $1 million goal. That would put people who start in their early 20s on track to retire in their 50s which is “retiring early” as far as the retirement planning industry is concerned. But almost 34 years of saving probably doesn’t sound very rewarding to those who thought saving 10% put them ahead of the game. It is not a recipe for retiring very early.
Increasing that savings rate to 15% shortens the time required to 29.3 years. That may be shorter, but still puts retirement a few decades away. Increasing savings to 20% shortens the time required to 26.3 years. Even saving 30% of salary requires over two decades, 22.2 years, to reach the $1,000,000 goal. I even tested a somewhat impractically high 50% savings rate, and it would still take over 17 years to achieve the same goal.
This brings up a couple lessons. The first is the incredibly important role of compound interest in producing large enough sums to retire. The example shows there is almost no way of getting around the need to be patient for at least a couple decades even at high savings rates. Those who start late have to contribute so much more to achieve the same retirement goals it can become borderline impossible.
The second is that retiring very early requires such an astronomical savings rate, it comes at a material cost to your lifestyle right now. The benefits of saving more must be weighed against what is sacrificed on the way. For this reason, there is no one-size-fits-all “good” savings rate, but simply what works best for you. If you need help determining what savings rate is the best fit for you, you may want to talk to a financial planner.
Rising Income Investments
Paul A. Ruedi
You may have heard me discuss the importance of “rising income investments” in the face of inflation lately. I am often using that phrase to describe stocks, but many people likely don’t know why I call stocks rising income investments and why they are so important to address inflation. I think it is helpful to look at the performance of stocks post-WWII until now, to answer both those questions.
The Standard and Poor's 500 Index earnings in June of 1947 were $1.13. Data from the end of June this year showed earnings of $201.13 (per politicalcalculations.blogspot.com)—178 times higher. Dividends at the beginning of this period were $0.71, and the most recent report showed that dividends on that index are at $64.02—90 times higher. This is why I refer to stocks as rising income investments; both company earnings and dividends paid to investors tend to rise over time.
Over that same period the cost of living rose by a factor of 14. This period included bouts of above-average inflation like we are seeing right now. But over the long term, even an increase in the cost of living of this magnitude is dwarfed by the growth of just stock dividends over that same period, which let me remind you, rose 90-fold. And that is just the dividends. The price of the Standard and Poor's 500 Index rose from 15 to 3,900 during this period—a 260-fold increase. Of course, we must always mention past performance is not an indication of future results.
On paper, everyone would invest in stocks for the obvious benefit of a rising income stream. But in reality, investing in a diversified portfolio of “the great companies of America and the world” is much more difficult. The rising income of stocks is delivered over long periods of time, but there are plenty of short periods of time where they will frustrate investors. There are times when inflation can run high and stocks will not provide a return to make up for that, like we are experiencing right now.
Investors will need to live through those tough times and stick with their investments in order to reap the long-term rewards of stock investing: an income stream that outpaces inflation by a wide margin. It sounds simple, but it isn’t easy. If you think you need help staying the course so you can reap the rewards of rising income investments, you may want to talk to a financial advisor.
Paul R. Ruedi, CFP®
When people think of retirement, they likely think of working a long stretch followed by a retirement that starts in their 60s and spans a few decades. Of course, the downside to this arrangement is that people spend their younger years working to have more freedom later, when perhaps they are not able to enjoy it as much. As a result, the concept of intermittent retirement has gained momentum lately.
Intermittent retirement, as the name suggests, is the concept of including short “mini retirements” of one to a few years to allow a person to take a break before returning to work. But of course, to pull this off requires a slightly different path as far as saving and some very careful financial planning. There are also some practical considerations regarding your ability to return to the workforce that should be considered as well.
From a financial planning standpoint, a person must save quite a lot in the years they are working to be able to take retirement years up-front at some points. Typical retirement savers have the benefit of a several decades of compound growth to turn the dollars they saved into a large enough sum to survive on for decades. People saving for intermittent retirement will not have as many years of compound growth to put the wind at their backs, and will ultimately have to save more or spend less to make the math work.
From a practical standpoint, it isn’t always easy to just stop working for years at a time. Constantly interrupting your career will likely hinder your ability to grow your earnings relative to someone who diligently focused on work the entire time. You can also catch bad timing from a macroeconomic standpoint if the end of one of your mini retirements happens to coincide with an economic downturn that makes jobs less available.
People who decide to pursue a path of intermittent retirement will likely feel these downsides are worth it for the potential upside of enjoying some of your retirement years earlier in your life. But I think it is important to remember you can’t borrow from your future indefinitely.
Eventually people grow older and they are not able to work, so they will need to have some sort of plan for those years. For this reason, intermittent retirement requires extremely careful planning to make sure you aren’t heading for trouble down the road. If you don’t have the expertise to do that yourself, you may want to talk to a financial planner.
The Cask of Amontillado
Paul R. Ruedi, CFP®
Edgar Allen Poe was a master of the horror genre, and one of my favorite short stories of his is “The Cask of Amontillado.” The story, which takes place in Venice during festival season, consists of the narrator exacting revenge on a man named Fortunato, who he feels has wronged him. To do so he lures Fortunato into an underground vault by promising to show him a cask of fine wine. However, once he has Fortunato where he wants him, he proceeds to build a brick wall right in front of him, trapping him forever. The inebriated Fortunato doesn’t realize what is happening until it is too late.
As a financial advisor I can’t help but notice when people build walls and trap themselves financially. It often happens slowly, or doesn’t seem like a serious issue at first, only for a person to discover the seriousness of the issue when it is far too late. I can think of several examples, but the one I see most often is overspending.
People are often lured into a lifestyle of overspending by modern day casks of Amontillado. Exotic vacations, fancy cars, and expensive nights out are enticing enough that people can’t help but take the bait. Overspending can often go on for years, with cash reserves dwindling and credit card balances building up slowly, just like the wall in front of Fortunato. Unfortunately, people often only become motivated to do something when the situation has become completely desperate. By then it is often too late.
Putting off saving is another example of a financial wall that builds slowly. People often think they can delay and figure out how to save for retirement down the road, not realizing they are slowly building a problem for their future that will be very difficult to overcome. Another example is having too conservative of an investment portfolio that won’t produce the inflation-adjusted returns to fund your spending in the later years of retirement. Another would be longevity, or outliving your money on the back end of retirement.
Suffice it to say, there are many financial walls that can slowly build over time unnoticed. These walls should be as horrifying as the wall being built in Poe’s story, but people often don’t see them that way. They often don’t even notice them until it is too late. I encourage you to look for any areas in your life you may be slowly building financial walls. If you can’t identify them yourself, you may want to talk to a financial professional who can.
The Retirement Road Trip
Paul A. Ruedi
Listeners of my radio show often hear me use the metaphor of a cross-country road trip to explain some of the most important concepts of retirement. In both cases, people set out on a long journey with a destination in mind. Unfortunately, many people start their retirement doing the road trip equivalent of starting out aimlessly in one direction intending never to make a turn.
While there is a small chance you could reach your destination this way, it is much more likely to lead to frustration or disaster. To reach your destination you will need some advanced planning, a road map, or set of directions. You will also need to be willing to make some turns and stops, both planned and unplanned.
With respect to retirement, a financial plan serves as your “road map” – but I suppose I should update that to Apple maps, Google maps, or whatever app you choose. Though you could try to just set out on the road and figure things out along the way by following signs or your intuition, anyone who has taken a road trip knows this isn’t a very good idea. Planning in advance and setting a course towards your goals is as essential to your retirement as a map or navigation app is for a road trip. It points you in a direction towards your goals and explains what you need to do to get there.
But you can’t be certain what will happen on your way to your destination. If anything, you should expect the unexpected, the retirement equivalents of stops for gas, traffic, and detours. A retirement plan needs to be flexible as it will need to adapt to whatever investment returns or life circumstances get thrown your way. Fortunately, if you take a wrong turn or get off course you can reference the financial plan to get back on track. Like a navigation app telling you to make a U-turn to get back on course, a financial plan can tell you what adjustments to make to get your retirement back on course.
The retirement road trip can seem complicated and overwhelming. But with some advance planning and the ability to adapt to what life throws at you, you can stay pointed towards your destination and eventually reach it. If you think you need some help planning for the twists and turns of your retirement, you may want to talk to a financial planner.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.