This week’s Big Picture will be a little different. I saw an interview on Bloomberg TV Saturday morning with a guy from American Express Financial Advisors, who is some sort of planner, named Chris Hamowy.
The interview was about retirement planning with the idea that most people will be retired for much longer than they might expect, thanks to longer life expectancy. Chris’s advice was wildly generic and uninsightful. He did manage to slip in that people should only work with large firms. I’ll leave that one alone, but what do you think about that idea?
That interview combined with the Businessweek special report on social security private accounts has motivated me to write my, possibly quasi-radical, thoughts on retirement planning and share what steps my wife and I are taking in our planning. Now, realize I live in a cabin on a mountain in the woods. Apologies if this resembles an excerpt from a manifesto.
It looks like people my age (38) will have a private account to provide some portion of their social security benefit. According to the Businessweek article the contribution will be capped at $1000 a year into the private account. I did not see where that cap might be raised, but maybe it will. If not, I might have 23 years of $1000 contributions. If I average 7% per year my account will be worth about $53,000. The article assumes we will buy an annuity with the lump sum. Annuity or not, if my calculations are anywhere close to right, the private account plus the “regular” benefit may not only fall short but may turn out to be a small fraction of what will be needed.
I don’t think anyone should expect social security to be there, nothing unique about that I realize. I also believe that there are enough savings mechanisms available to save what you need, but you need to take advantage of them.
I think I saw Suze Orman say not to put money in a 401k, to use a Roth instead. So that I don’t get sued; I’ll just say I disagree. If you have a 401k use it. I would say to max it out but at the very least put in enough to get the most out of the employer match. There are some instances where a 401k may not be the best thing but the reason I like it is you only need to be disciplined once (when you sign up), not every paycheck. A 401k builds up very quickly. Being self employed I do not have access to a 401k, although recently a product called an individual 401k has popped up, but I haven’t looked into it yet.
The next thing I would recommend after your 401k is a Health Savings Account, as soon as one is available to you. There are plenty of articles out there you can read to learn about them, they are a great vehicle, my wife and I are going to start one this quarter.
After funding the HSA the next account we use is a Roth IRA. We each have one, and I’m sure by now you know the advantages over a Traditional IRA.
Between the HSA and two Roths we will put away about $11,000 this year. While that doesn’t sound like much it is more than we need thanks to some diligent savings that started in my mid 20’s.
Here’s where I start to veer off the path. Planners say you need 70% of your income in retirement. I have never understood this. Most of the people I know that are retired or close to it have no mortgage. That might be something to shoot for. Also most retirees I know don’t have car payments. That may be a little tougher, but with minimal planning you should be able to work it so you never have two car payments, right? With no mortgage and only one car payment I would think that might cut fixed expenses in half if not more. It is also unlikely you will have the expense of raising children in your retirement years. If you think about your expenses ex-mortgage and only one car payment the only variable is the cost of health insurance. You know what to expect inflation-wise from just about every other fixed expense. I would encourage you to think in these terms.
Another thing to think about is Multiple Streams of Income. I read this book a few years ago. I don’t remember the details but the concept made quite an impression on me. I love the type of work I do enough to keep doing it until the end. It probably makes sense to find something you like that much. For example a neighbor, who is 74, owns a back hoe and has to turn business away. He gets paid $65 an hour to play around on his Tonka Toy. Work you love can be one stream.
Your investment portfolio will be another stream of income. Keep withdrawals to 5% or less.
Another potential stream I believe in, that I don’t write about much is real estate. Let me say up front I like simple. In a year or two we plan to buy a six unit apartment building (maybe four units or maybe eight). The idea is that ten years from now normal inflation may cause rents to go up 50% from where they are now while the mortgage payment will be the same, giving a substantial positive cash flow. Real estate in Prescott (the town where I live) is not very expensive so we will be able to afford to cover any negative cash flow that might come from vacancies. If you go that route it may make sense to learn how to do some simple repairs. I have a little experience with plumbing and a little more with electrical work. Expect a lot of little problems, owning rental property is not easy.
Lastly is live below your means. There is something I heard a long time ago that rings true for me as a philosophy; who is richer, than man who makes $20,000 but only spends $10,000 or the man who makes $200,000 but spends $210,000?
Obviously I have simplified every point made in this article. The idea was not to imply one way is right for everyone or that I think I have all the answers. I did want to try to get you to think outside the lines a little bit. Like investing, personal finance continues to evolve. This is why you have a financial plan and why you review it.
But that’s just me.