Archive for the 'Retirement' Category
Monday, May 20th, 2013
NPR Morning Edition featured a story today about non-traditional retirements: Seeing The (Northern) Light: A Temporary Arctic Retirement. Instead of waiting until 65, Winston Chen decided to stop working for an entire year mid-career and moved his family to a small Norwegian island in the Arctic Circle with only 180 residents.
The whole family got to do many things they’d never do otherwise. Financially, they offset their mortgage by renting out their Boston home completely as-is for a year to another family on a temporary work assignment. His wife Kristin was able to get a job teaching elementary school in Norway for a year, as it was a remote area that needed teachers. They could keep expenses low as the tiny village had no need for a car, no malls, and no restaurants. One of his pursuits ended up being an iPhone app that took off and now supports their entire family, although that wasn’t the goal.
The inspiration came from the TEDtalk “The power of time off” by designer Stefan Sagmeister. Here’s a screenshot (sorry for the poor quality) illustrating the traditional working timeline: learn for 25 years, work for 40 years, then retire for 25 years.
A commenter pointed out that this shows that our society seems to feel that education is for the young, work is for the middle-aged, and leisure is for the elderly. But what if you decided to snip 5 years from those retirement years and sprinkle them between your working years? This is essentially the idea of sabbaticals, usually associated with tenured professors taking a paid year off from their usual teaching and research duties. Every 7 years, Sagmeister completely shuts down his popular design shop for an entire year.
Both Sagmeister and Winston Chen add that if you do this, you shouldn’t just give yourself a year of nothing and expect to figure it out along the way. At the minimum, you should make a list of all the things that you want to try and/or accomplish (Chen’s included oil painting, photography, reading, learning Norwegian, and learning how to play the ukulele). Both broke it down into a daily schedule as well (Chen’s is below).
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Monday, April 29th, 2013
Stephen Wolfram, of Mathematica and WolframAlpha fame, used his natural language analysis tools to crunch through a huge set of Facebook data. The results are some interesting visualizations, including a series of charts about how the popularity of a topic varies with age. For example, both men (blue) and women (red) post increasingly more about career and money topics between ages 15 and 30. After that, interest levels stay pretty much constant for the next 30 years. I suppose it’s because virtually all of us are still working until then.
Here’s the chart for family and friends; I wonder if the drop in the 20s is due to a focus on finding a partner? Other than that, the gap between men and women seems pretty constant.
A growing gender differential occurs in terms of health-related topics. No wonder us guys don’t live as long.
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Monday, April 22nd, 2013
Time for fun with charts! A famous chart in the early retirement community is The Crossover Point from the book Your Money or Your Life, which shows that you’ve reached financial independence when your investment income equals your monthly expenses:
Fellow blogger Adrian of 7million7years also shared a related chart from Chris Han of Quora, where wealth is the shaded area between your income and expenses:
Specifically, if you plotted all your income and expenses over time, the shaded area between would the amount you’ve saved your entire financial life. Bigger shaded area, bigger nest egg.
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Tuesday, February 26th, 2013
Updated and revised. Fidelity Investments does a lot of things well, but their Fidelity Freedom series of target-date retirement funds is not one of them. I’ve been warning people about these funds since 2006, although recently they’ve been getting some heat due to their overall underperformance. Assets in the Freedom funds have been dropping, while the assets in Vanguard’s Target Retirement funds have been increasing quickly. Here’s why the underperformance is not about the glide path, but about the structure and fees.
This post is a bit long, so here’s a roadmap of what I’m going to try and show:
(1) The goal of owning actively-managed mutual funds is to beat their passive benchmark. Pick the winners and not the losers. The problem is that Fidelity Freedom funds hold so many different funds with overlapping holdings, that in the end they basically own everything. It’s exceedingly difficult for them to accomplish such outperformance. Thus, over time their performance before fees is likely to simply match that of their benchmark.
(2) Due to their higher expenses, this means that their net performance after fees (what investors actually get) will be very likely to underperform the their benchmark. Over long periods of time, the amount of underperformance will closely match the amount of management fees charged.
(3) This expected underperformance is confirmed by looking at their historical performance over the past 3, 5, and 10 years.
(4) Instead, investors should look for low-cost index funds to replicate the benchmark give the best chance of higher performance. Options are explored.
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Wednesday, January 23rd, 2013
Here’s a belated 2012 year-end update of our investment portfolio, including employer 401(k) plans, self-employed retirement plans, Traditional and Roth IRAs, and taxable brokerage holdings. Cash reserves (emergency fund), college savings accounts, experimental portfolios, and day-to-day cash balances are excluded. This is the portfolio that we are depending on to create income and thus financial freedom.
Asset Allocation & Holdings
Here is my current actual asset allocation:
The overall target asset allocation remains the same:
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Friday, December 14th, 2012
Behavioral economists are constantly trying to find ways to convince us do the “right” things like save for retirement. Why is it so hard to give up short-term perks for larger, long-term rewards? For example, take my True Cost of Holiday Shopping calculator and this Warren Buffett anecdote from a 2011 WSJ article:
Warren Buffett is one rare—and extreme—example. When he was a young man, according to Alice Schroeder’s biography “The Snowball,” Mr. Buffett often asked, “Do I really want to spend $300,000 for this haircut?” He was thinking about the vast amount of money he wouldn’t have decades in the future because of the small outlay he might make in the present.
I think it’s fair to say that most people don’t think like that. (It appears he did get haircuts at least once in a while.) According to Stanford researchers, one big reason is because we struggle to identify with our future selves. The researchers are quoted in this Wired article:
To people estranged from their future selves, saving is like a choice between spending money today or giving it to a stranger years from now.
In their study, they used advanced virtual reality goggles make some people see older versions of themselves. Afterwards, the test subjects who saw their elderly avatars stated they would save twice as much as those who didn’t. Merrill Edge, the brokerage arm of Bank of America, has created an online version of this aging process called Face Retirement. It takes your picture via webcam and ages your face to help you better visualize “old” you. I got to see myself at age 47 to 107, in 10-year increments.
Will it work? I’m not sure. My wife says I just look like a zombie, especially at 107. Maybe there would be more shock value if it showed me eating dog food or something.
Monday, November 19th, 2012
The IRS recently announced increased contribution limits for various qualified retirement plans for tax year 2013. The limitations are indexed to increases in cost-of-living (inflation) as per section 415 of the tax code. In particular, the elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $17,000 to $17,500. However, the additional catch-up contribution allowed for those age 50 and higher remains $5,500.
The limits are the same for both Roth and “Traditional” pre-tax 401k plans, although the effective after-tax amounts can be quite different. Employer match contributions do not count towards the $17,000 elective deferral limit. (Although technically the total annual defined contribution limit is $51,000 for 2013… let me know if you have an employer that is so generous!) Curiously, some employer plans set their own limit on contributions. A former employer of mine had a 20% deferral limit, so if your income was $50,000 the most you could put away was $10,000 a year.
Here’s a historical chart and table of recent contribution limit increases:
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Sunday, November 18th, 2012
The IRS recently announced the Traditional and Roth IRA contribution limits for tax year 2013. The limitations are indexed to inflation, but only in $500 increments (as of 2010) which are triggered when the cost-of-living calculation reaches a certain threshold. The threshold was finally met, so the limit on annual contributions to an Individual Retirement Arrangement (IRA) increases to $5,500, up from $5,000. However, the additional catch-up contribution allowed for those age 50 and higher remains $1,000.
The limits are the same for both Roth and Traditional IRAs, but each one has their own unique set of eligibility requirements. IRAs are “individual” accounts by definition, so the limits are per person. The deadline for 2012 tax year contributions is the same as the 2012 tax return filing deadline: Monday, April 15, 2013. Tax return extensions won’t apply to this cutoff.
Since I like visual aides, here’s a historical chart and table of recent contribution limits. I’m proud to say that we’ve both done the max since 2004. Have you been taking advantage of your potential IRA tax break?
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Friday, September 28th, 2012
Here’s yet another retirement rule-of-thumb, this time by Fidelity Investments.
[...] the average worker may replace 85 percent of his pre-retirement income by saving at least 8 times his ending salary. In order to reach the 8X level by age 67, Fidelity suggests workers have saved about 1 times their salary at age 35, 3 times at age 45, and 5 times at age 55.
As usual, these number are based on a long list of assumptions. Start saving at age 25, retire at 67, nice gradual income growth, nice gradual portfolio growth, and so on:
The company’s 8X savings guideline is based on a hypothetical worker saving in a workplace retirement plan, such as a 401(k), beginning at age 25, working and saving continuously until 67, and living until 92.
• The employee will make continuous annual salary contributions to a workplace plan beginning at 6 percent and escalating 1 percent per year until 12 percent, plus receive an ongoing 3 percent annual employer contribution during their career.
• The calculation assumes a lifetime hypothetical average annual portfolio growth rate of 5.5 percent.
• Social Security payments are factored into the replacement income ratio of 85 percent.
• The employee’s income grows by 1.5 percent per year over general inflation with no breaks in employment or savings.
Focusing on the positive, these age-based targets are meant to be more helpful when setting goals than big, scary numbers. Also, these rules reinforce the idea that starting early is very important as it gives compounding time to work.
But again, we see the same-old assumption that you will constantly spend a certain % of your working income. Why? The implicit acceptance that spending should be linked to salary keeps you from ever getting ahead. Think about it; Your spending can be completely independent of salary. Instead, you earn more, you spend more, and the hamster wheel goes ’round and ’round:
The reason why I write is that working 40+ hours a week for 40+ years is unacceptable to me. Retirement rules should be based on your spending, not salary. Salary is important, but your spending determines how much money you need to save. Your spending is also much more under your control than most people admit. 25 times your annual spending; That’s my guidepost.
Tuesday, September 25th, 2012
Schwab recently announced lowered expenses on all of their 15 Schwab-branded ETFs, undercutting everyone else’s comparable ETFs in every category, including Vanguard. Quite a bold move! Here is a limited comparison of comparable Vanguard and Schwab ETFs. The asset classes are picked to include the common asset classes as mentioned in many passive investing books and articles, but admittedly biased towards the ones that I like to use in my own portfolio. This way, I can also note which asset classes are not covered.
Briefly, an expense ratio of 0.01% means that on $10,000 invested you would be charged $1 a year in fees. The fees are taken out of the ETF’s share price, or net asset value (NAV), a tiny bit each day. So a difference of 0.03% (3 basis points) on a $10,000 investment would add up to just $3 per year.
|New Expense Ratio
|Broad US Stock Market
|Broad International Stock Market
|Developed International Stock Market
|REIT (Real Estate)
|Broad US Bond Market
|US Treasury Bonds – Short-Term
|US Treasury Bonds – Intermediate-Term
|US Treasury Bonds – Long-Term
|TIPS / Inflation-Linked Bonds
My comparison differs from the Schwab-provided version in the area of Treasury ETFs, with what I think are more appropriate Vanguard pairings. As Vanguard does not have a TIPS ETF, I should note that the Schwab TIPS ETF compares favorably to the popular iShares TIPS ETF (ticker TIP) with an expense ratio of 0.20%.
If you already have your money with Schwab, this is great news and a good sign for the future that they are committed to building up some decent-sized assets and trading volume on their ETFs. (Vanguard’s higher asset sizes and volumes mean lower bid/ask spreads and smaller NAV deviations, resulting in lower overall trading costs.) In a Schwab brokerage account, you can trade Schwab ETFs commission-free.
However, if you’re already investing with Vanguard, I don’t think these small expense ratio differences are enough to warrant moving assets especially if you have unrealized capital gains. (You can also trade all Vanguard ETFs commission-free inside a Vanguard brokerage account, and also many of them free at TD Ameritrade.) Vanguard has a long-standing commitment to “at-cost” investing and passing their savings onto the retail investor. In contrast, Schwab is almost certainly losing money on many of these ETFs, and thus using the low expense ratios as a temporary loss-leader “sale” to attract assets. For example, their bond ETF (SCHZ) currently has $316.5 million in assets and thus only generates around $158,000 a year in fees. That’s probably less than one employee salary at Schwab. In other words, I don’t think a substantial savings margin is sustainable over the horizon of many decades. I’d still recommend Vanguard for new investors, especially as Vanguard also has cheaper stock commissions for outside ETFs and individual stocks ($7 or less vs. $8.95).
A good point brought up in the Bogleheads forum is the ability of some people to gain access to these Schwab ETFs in their 401(k) retirement plans through the Schwab Personal Choice Retirement Account® (PCRA). If your retirement plan offers such a brokerage window, you may be able to trade these cheap Schwab ETFs for free with your tax-deferred money. Most PCRAs charge an annual fee of around $30-$50. Unfortunately, I found out that due to silly regulations, if you have a 403(b) plan your PCRA account is limited only to mutual funds. However, Schwab does have a small selection of low-cost index mutual funds as well.
Wednesday, September 12th, 2012
How about another mental exercise on taxes? I usually enjoy Christine Benz’s articles on Morningstar, and When Taxes Collide With Your Asset Allocation was no exception. She presents the following scenario:
Let’s say a 65-year-old woman is prepping her portfolio for retirement. Her assets are ultra-streamlined, with a $500,000 Roth IRA account containing stocks and $500,000 in a traditional IRA portfolio consisting of bonds.
Is her asset allocation:
a) 50% bonds and 50% stocks
b) Heavier on stocks than bonds
c) Both of the above statements are true.
The basic premise of the article is that because she has to pay taxes on withdrawals from her Traditional IRA accounts at ordinary income tax rates, while not owing any taxes on her Roth IRA accounts, the woman effectively has more exposure to stocks than bonds. I agree that taxes are an important facet to consider.
However, Benz makes a quick assumption that her federal income tax rate is 25%. Here we meet the difference between marginal and effective overall tax rates, as well as the difference between gross and taxable income, in our progressive tax system. While the woman’s marginal tax rate may be 25%, unless she has a lot of outside income, her effective tax rate on those bond withdrawals would be much less. In fact, my wife and I would like to pay zero taxes in retirement with a similar portfolio.
How? Let’s say we are a couple both age 65 as in the example, which is over 59.5 we can start taking withdrawals without penalty. We have no pensions to rely upon. Like above, we have $500,000 in Roth IRA and $500,000 in Traditional IRA. With 401k plan rollovers and regular IRA contributions, this is not unrealistic. With a 4% withdrawal rate that is $40,000 a year, let’s say $20,000 from both.
What taxes do we owe? The $20,000 Roth IRA withdrawal is tax free. Now onto the $20,000 Traditional IRA withdrawal. Well, since this isn’t earned income, you won’t have to pay any payroll taxes like Social Security and Medicare taxes. For 2012, the standard deduction for a married filing joint couple is $11,900 plus $1,150 per person for being 65+ and the personal exemption is $3,800 per person. That adds up to $21,800. That’s more than $20,000, so our taxable income is zero! In fact, the first $17,400 of taxable income is taxed at the 10% bracket, so your total withdrawals could total up to $39,200 and still owe an overall percentage less than 5%.
As always, there are things that could skew the math. You might have a pension. There’s also the possibility of state income taxes, although if we take California the effective tax rate would less than 1%. Finally, Social Security benefits could create a greater tax liability, although it might be wise if you’re healthy to defer Social Security until age 70 to maximize the payout of what is effectively an inflation-adjusted lifetime annuity.
When you contribute to a Traditional IRA, you take the tax break upfront and pay taxes later. When you contribute to a Roth IRA, you pay taxes now and take withdrawals tax-free after age 59.5. Keep in mind this example when choosing as by carefully mixing the two, your effective tax rate in retirement may be lower than you think.
Monday, August 13th, 2012
An increasingly-crowded space is the online investment portfolio manager, which promises to help you invest better while costing a fraction of what conventional financial advisors would charge. Here is an incomplete list, including several services that I’ve tried and reviewed:
I support the overall vision and enjoy seeing all the new developents, and I think that many of them show promise. Selfishly, I figured that I’d put up my personal wish list of features as a DIY low-cost investor. Many of the services listed above do one or more of these things, but so far none have done enough to replace my current method of using a manually-updated Google Docs spreadsheet.
Import my existing portfolio automatically. Similar to Mint, I should simply provide my login details and have all my portfolio holdings and activity imported and synchronized automatically on a daily basis. Security is a concern here, and it would be really nice if brokers created a “read-only” access protocal, similar to what Capital One 360 has set up for its savings account. SigFig (formerly WikInvest) does this aggregation part reasonably well for many popular brokers.
Track asset allocation across entire portfolio. Many folks have investments spread across various places – 401k, IRA, SEP-IRA, taxable account, etc. I want to know my overall asset allocation across everything. Stocks vs. Bonds, US vs. International, Large-cap vs. Small-cap, Growth vs. Value, please break it down as fine or as broadly as I’d like. This may take some learning by the software in the case of some niche investments like stable value funds or individual bonds. I’ve seen Personal Capital learn asset classes quickly, so it’s definitely possible.
Customized rebalancing alerts. I want to be able to set my own target asset allocation as well as tolerance bands, and have the software send me an alert when I need to rebalance. They could even tell me “buy $X,XXX of Large-Cap US stocks” or “sell $X,XXX of Corporate Bonds”. This is a critical feature of my Google Docs spreadsheet, as it tells me where to invest new cash inflows. MarketRiders provides rebalancing alerts for a fee, but they don’t import data automatically.
Detailed performance stats vs. benchmarks. Even though I’m mostly a passive investor, my actual performance will still depend on the timing of my investments. I’d like to know my “personal rate of return”, which some brokers like Fidelity and Vanguard are pretty good at showing me. But again, I want to see numbers across my entire portfolio. How does my return compare with various benchmarks?
Reasonable cost. Some services are ad-supported or charge based on asset size, but I would be willing to pay around a flat $100 a year or $10 a month for such a product. That’s not much, but I think all of the above can be done with software and thus should scale easily. 10,000 people paying $100 a year is still $1,000,000 a year. Perhaps a company like Morningstar could offer access as part of their premium service, or it could be licensed to an E-Trade or TD Ameritrade.
What features are you looking for that haven’t been met?