Kitces on Spending and Retirement

For those who don't know, Michael Kitces is a rarity - the smart financial planner and an original thinker.  Most financial planners I know are really good at learning complex rules for all the various situations that come up in the financial arena but not so much at questioning the consensus view.

Here is a piece, "Retirement success is about spending, not saving," he recently wrote for MarketWatch in which he looks at the simple notion of  saving a given percentage of income starting at a young age and exploiting compounded returns to get a six-figure nest egg.  Many readily accept this as the simple key to building a sufficient nest egg.

Kitces finds two caveats with this.  First off, the simplistic analysis actually assumes the nest egg will double in the last 10 years (in the real world, sequence of returns is important whereas people like to simplify and just use averages).  Think about this:  if we assume we're compounding at 8%/year, then we are assuming that the fund doubles in the last 9 years (think rule of 72).  Over that 9-year period, the fund appreciates, for example, from $500,000 to $1.0 million.

It doesn't necessarily work out like this in the real world.  Not a good thing to realize on your 65th birthday!

Another problem is that saving a fixed amount may not keep up with lifestyle.  Consider an extreme example, where you make $40,000/year and then in the last 10 years you make $400,000/year.  Saving 10% of income/year will leave you woefully short of financincing the lifestyle you've enjoyed your last 10 years of work.  Kitces emphasizes it's not just about saving but is about spending as well.

The whole business of how much needs to be saved, and even how much can be safely spent in retirement, is tricky.  In fact, it amounts to a Rubik's cube.  We don't know how long we will live, how the markets will treat us, or what inflation will be.  Spin the cube and the results can change meaningfully.  Only the minority will come close to realizing their goals.  The rest of us will be forced to ramp down lifestyle or kick the bucket with much more left over than we would like.  We will either have to take less trips, and eat at Hardee's more, or end up so that we would have preferred more weeks at Sanibel and more creme brulees than we had.

Still, Kitces's observations point up, at least to me, the importance of ongoing financial planning.  At least twice/year plans should be revisited (even if just using TRowe's free online calculator or a similar calculator) to even have a shot at getting the process halfway right.

$300,000 Party?

Please, please, please

Here we go again.  This time it's Vince Young, former NFL quarterback.  $26 million, 2006, guaranteed.  Today, Ronnie Peoples, who is involved in this fiasco, characterizes Vince Young's financial situation: "not good."  It is said he took out a high-interest loan to throw himself a $300,000 birthday party.

Please, please, please (listen to Mr. James Brown) ... someone give them or someone around them who is responsible my name and number.  I have none of these big name athletes for clients, but I can tell you I will call them stupid to their face at the very mention of funding posses, throwing $300,000 parties, buying a $176,000 Ferrari, or having to take out a high-interest loan.  Part of the sad part of this is that Vince Young (as far as I can tell) is one of the good guys!

Still, I have no problem calling them ignorant if they don't put at least half their earnings away in safe investments.  Help me out here - if you can't live large on $13 million, you've got a problem.  I will use the behavioral finance procedure of aging their picture so they can be introduced to their future self.  I will go with them to the local warehouse or construction site and talk to people who work for 40 years to make less than one 10th of what they make for signing a contract.  If they don't like it, they can fire me - I don't care.  But I won't treat them with kid gloves.

My clients don't really have a choice.  They quickly realize they need to play their cards smart to have a shot at a decent retirement.  Even then, life events can pop up that upset the proverbial apple cart. But here we have athletes and movie stars et al. blessed with a talent and lucky enough to be born in a society that values that talent, to an outrageous extent, and they throw it all away.

You would think that, since most of them went to college, they could read and understand what has befallen those in similar circumstances who have come before.

Recommended Holiday Gift - Latest Jeff Yeager Book

Source: Amazon

To me, experience counts for a lot.  You can have a PhD in family matters; but, if you haven't raised teenagers, you'll have a difficult time getting me to pay attention to your child-rearing theories.  For the same reason, I have a difficulty with investment advisors still wet behind the ears--I don't care how many designations they can put behind their name. But... that's the subject of another post.

A company I worked for, once upon a time, gave periodic presentations to people on the verge of retirement.  The financial planner guy would go over financial planning issues, I would talk about managing the nest egg and creating a paycheck in retirement, and finally the President of the company would pop up and answer questions.  This was the first half.

The second half would typically present a panel of retirees who had previously worked at the company.  They would tell stories on what retirement was like and hit upon their successes and what they would do differently if they had it to do all over.

Not surprisingly, the audience sat up a little straighter and blinked a few times to get refocused as the panel spoke.  This was them a few years down the road.  They were meeting their future selves.  By listening closely to the panel, the audience could very well get answers to questions they had been mulling over.  Broad questions like "can I retire early," "how do I know if I have enough to retire," "what will I do in retirement," etc.

My question to myself at the end was why this kind of thing isn't done more often.  I even thought about the "Scared Straight" program on TV where incorrigible teenagers on the path to becoming a menace to society are given a "tour" of Rahway State Penitentiary to get an insider view of prison life from the inmates.  What could be a better deterrent?

To me, experience counts for a lot.

 The Cheapskate Way

Jeff Yeager's latest book How To Retire The Cheapskate Way is filled with stories of people who are successfully going down a debt-free road, living within their means, and achieving a goal of what he calls "selfishly employed," i.e., employed doing what they want to do.  In fact, he is one!  This book is experience writ huge!

Most people who think about retirement concentrate on the income side.  I'll admit I am guilty of this.  I hammer away at investments and creating a large "nest egg."  I emphasize relating money needed to achieve an income based on what was needed in the pre-retirement years.  But retirement is different from pre-retirement - especially for people who pay attention to where their money goes.  And the financial expert guy (or gal) with "the big binder" isn't going to be a lot of help to people who truly understand their finances.  This is one of Yeager's main points!

In between the stories and Yeager's expressions that will get you to laugh out loud (not easy for authors to do, in my case), there is a serious challenge here for the financial planning profession.  He presents evidence questioning the widely-made assumptions on retirement spending needs.  In particular, if you are buying into the notion that you need millions to happily retire, Yeager will challenge your beliefs.

The focus in this book is on spending.  The stories show that many people have learned how to get along on much less than is conventionally presented.  It tells the story of people saving and creating income in unusual ways.  It tells of people thinking outside the box - one couple got their kids a dump truck load of dirt for Christmas.  The kids were thrilled!  And, you guessed it - the dirt was dumped at the low spot in the yard!

It gives some direction in dealing with the thorny issue of medical care for the early retiree.

Part way through, I was reminded of a presentation I attended put on by the local chapter of the American Association of Individual Investors.  A broker was going through a complicated explanation of what to do if a retiree's income wasn't sufficient when, all of a sudden, a hand shot up.  The audience member said that he would figure out his Social Security, his investment income, and his small pension and then do what he did his whole life--he would "live within his means."

This threw the presenter for a loop.  He clearly had not thought of the problem from this perspective. To him, if you had a shortfall, you automatically first considered taking on more investment risk.

Yeager loads his book with references to resources enabling the reader to follow the Cheapskate path. In case there is a question, Cheapskate doesn't imply that a person isn't generous.  Cheapskate Verna Oller replaced broken shoelaces with a zipper from an old jacket but in her death revealed a generosity that will surprise you.

Recommendation

I highly recommend this book for anyone on your holiday list past their midlife crisis.  For one thing, it is cheap.  For another, it will be available in January after all the holiday hooplah has died down and your giftees are looking for a good read to settle down in front of the fire with.  After they read it, they will thank you and hopefully lend it to you.

Warren Sapp Bankrupt

According to Sports Illustrated, 78 percent of NFL players and 60 percent of NBA players file for bankruptcy within two years of their retirement. Is exorbitant spending to blame? A lack of financial planning and education? Or a lack of common sense?

This quote came from WP Sports blog post on the bankruptcy of Warren Sapp.  I find it hard to believe the numbers, but still there definitely seems to be a rash of bankruptcies.

Most of us can't relate to professional athletes.  They make a humongous amount of money at a young age over a very short period of time.  They are made to believe they are God's gift to their sport and, unfortunately, to the opposite sex.

I assume the player's union and their agents give them great financial advice.  Still many blow it.

Sapp is the latest to garner attention.  It is reported that he made over $60 million in his career.  Today he is $6.7 million in debt.

I had a financial advisor friend one time tell a story about going to New York in a limo with a player on the Washington Bullets (now the Wizards) - a young rookie who truly was a b-ball phenom.  In the limo was an agent and a couple of "friends."  They were headed to New York to talk about a deal to make a rap record.  Guess who was footing the bill. I n New York, the people at the table weren't happy to see my friend there.  I wonder why.

It is too late to help Sapp, but I feel I should step forward and offer my services to those with the big bucks ( where are you mega millions winners?).  I have a radical approach called "set money aside and invest it conservatively" and then do what you want with the rest.  For example, if we turned back the clock with Sapp, I would have recommended taking $5.0 million (chump change for him back then) and investing it conservatively at 4% to produce $200,000 as long as he would live.  I would have tried to explain that he didn't have to try to get rich - he was already rich.  Then we would have talked about living on $200,000/year when he retired, if that's "all" he had.

Most athletes, I believe, would be able to manage this even after paying child support and alimony. .

It should be noted that athletes get all the publicity.  How many people outside of entertainment come into the big bucks and blow it, absent all the publicity?  There are surely many.  If you get to them before I do, feel free to pass along my advice.

How Hard is Financial Planning?

Michelle Singletary, financial columnist for The Washington Post, described on Sunday a friend's financial issues.  The friend is 65 years old, was recently laid off, and now is perplexed by numerous financial issues.  These include whether to take a lump sum or a pension, when to take Social Security, should she roll over her 401(k), etc.  The friend doesn't have the information at hand, hasn't thought about these issues, and Ms, Singletary claims, "She shouldn't feel guilty."

I disagree.  She should feel guilty.  These are issues people need to take responsibility for way before they reach 65 years old.  They need to either meet with a financial planner and sort them out or figure it out themselves.

The theme of this site, of course, is that most people can figure out much of it themselves.  The starting point is fairly straight forward and, rather than listing numerous questions that mix the issues up, I would rather that Ms. Singletary had proceeded systematically.  The starting point is to figure how you will get paid once you no longer are working at your primary job.  Anybody who is 50 or older and hasn't done this should stop reading and go do it.  Find out about Social Security, throw in your pension, and finally throw in 4% of your nest egg.  Add up and ask yourself if you can live off that number.  Most people can't and will have to continue saving and probably have to ramp up their saving.

Once you've started down the path to understanding your retirement situation, you'll want to get more sophisticated.  There are good calculators online, that are free and easy to use, that will automatically get you to answer the questions posed by Ms. Singletary.  One I like is FIRECalc, but there are a number of them that can be found by googling "retirement calculators."

For what it's worth, I think most people who don't know probably think financial planning is a horrendous undertaking  on par with doing your taxes.  Again, I would disagree; and I think many people are in my camp.  It can be an interesting eye opener to get a handle on your financial situation and strategize for that day when retirement arrives.

In terms of getting started, it makes a lot of sense to at least meet with a financial advisor and schedule at least two hours to go over the whole process--including an approach to managing investments.  In my experience, this  meeting typically more than pays for itself as the advisor shows the client some areas where taxes can be saved and expensive investments avoided.

For those who thumb their noses and go "neener, neener," I say "you are guilty."

DIY Investing Wrap-Up

The last four posts have outlined the 3 steps to DIY investing:

• Pick an asset allocation model - This can be done inside or outside the brokerage firm you use ( assuming they offer it). The advantage of using the brokerage firm model is that everything is in one place.
• Choose investments - I prefer low-cost index funds but also allow for some individual stock investing. Either way, it is crucial to have a handle on how well diversified the portfolio is and how the investments fit in the overall allocation.
• Monitor the portfolio - Keep track of the allocation over time. This will enable you to rebalance when appropriate. The rule you use is up to you. At the outside, I rebalance automatically when the targeted allocation to an asset class is 5% away from target.  Monitoring the portfolio also involves tracking performance relative to a well-defined benchmark.

With this basic framework setup, anyone can  manage their own investments without having to make a major time commitment. A huge amount in fees will be saved over the long run which will accrue to the bottom line, compound, and leave  a much bigger nest egg.  Also, you will get a good feel of the overall investment process. Forget scratching your head and wondering why the heck your advisor is holding on to Fannie Mae or what the CTA fund is he or she has invested you  in. Forget wondering why your advisor isn't returning your calls.

How will you do performance wise? Well, no one can guarantee future results; but numerous studies have demonstrated that an approach that minimizes costs and is well diversified has outperformed approximately 80% of active professional managers over the long term, after accounting for all costs. Furthermore, the evidence shows that it is impossible to select the active managers ahead of time that will "beat the market."

There is, of course, more to the financial picture than managing investments. For the additional information, most individuals should consult with a financial planner. A good plan will run about $2,500 and will look at your insurance needs, financing college, estate planning, and even investments. It will go over location of investments, what you need to know to roll over accounts, and things like titling inherited accounts. Once a bit of complication enters your financial life, a plan is worth getting.

For many people, the best route is to pay for the plan and save on the investment management side. A couple of good books for those who like to read up on retirement planning (not a bad idea before meeting with a planner):

Start at Community College or 4 Year School?

Ron Lieber of the New York Times has written an excellent column on this question: "Bargains on the First 4 Semesters."

Given the dollar amounts involved, the financial planning considerations are important. The parent's retirement plans can be affected by the choice of college along with the student's loan burden.

The article contains excellent recommendations along the lines of checking out the community college, talking to advisors, not taking courses that are too specific at the community college, finding out how many transfer students actually graduate from a 4-year college, etc. To me, anyone who would follow these recommendations is a serious student and would have no problem going the community college route. The worry for many people is the academic environment. I have taught at both the community college level and a 4-year major college. The academic environments are different.

The community college I teach at is nationally recognized as an excellent institution. It has outstanding honors programs from which the transfer rate is exceptionally high and for which the 4-year graduation rate is high. To me what is  lacking, compared to a 4-year university, is the opportunity to join a hard-partying fraternity or sorority and big-time college sports. The education in the honors programs at the community college can be, I believe, superior to the university for the first 2 years, when individualized attention is considered.

Away from the honors courses, community college is a bit different; and the student who desires to successfully transfer to a 4-year school needs to be highly motivated. The non-honors courses are populated by students who decided at the last minute to attend community college (maybe because they couldn't get a job), didn't take a college level track in high school, have no idea of a career path, and very likely are taking remedial math and English courses.

At the university, it is different. Students have prepared for college in high school, have gone through a rigorous process to get accepted, and many have the necessary math and English skills.A higher percentage of the students know why they are there.

One advantage I believe that the community college offers is that the instructors tend to have real-world experience. Many of the instructors are adjuncts who are practicing law, accounting, economics, or nursing in the real world and can provide excellent advice on career paths.

I, for one, felt I was better prepared entering the university 3-credit-hours-short of junior status with an AA degree from community college.

Up Your 401k Contribution in 2011

If you are not maxing out on your 401k, you have an opportunity to easily put in an additional 2% in 2011 because of the cut in the payroll tax. This advice comes from "Getting Your Financial Ducks in a Row." If you are maxing out on your 401k contribution, then you should consider putting it into a Roth or even a taxable account, Jim Blankenship says.

Polls show that the biggest financial regret seniors have is that they didn't save enough.

Have a HAPPY NEW YEAR!!!!!!!!!!

Meeting With an Investment Advisor

The focus of my practice is to offer advice and management services for people to get their investments on track. How does this work?

For many people, it is a matter of two meetings. The first meeting we'll have is to gather information and get to know each other. I'm interested in getting the big picture. We fill out a questionnaire. I'm interested in where you are on the path to retirement. Ages, types of assets owned, number of years to desired retirement, etc. are all obviously important. I am interested in whether you seek to finance college educations, your insurance situation, whether your job is secure, etc. I am interested in your saving habits.

In the first meeting, in addition to the basic questionnaire, I have a couple complete a simple risk-tolerance type of questionnaire. I ask questions about your past investment experience. Many times, by understanding reactions to the 2008 debacle, I can get valuable insights into risk tolerance.

I typically spend about 15 minutes discussing my investment philosophy. If you aren't sure if you are interested in my services, I usually cover my philosophy in the first 15 minutes. This is the part where there is no obligation. If there is no interest in the low-cost, low turnover, indexed approach then we'll shake hands, I'll wish you luck, and we'll part ways.

I gather your most recent statements and the list of assets available for investing.

Once I sit down with this information, I begin by ordering accounts starting with the taxable accounts, then the qualified accounts (401ks, 403bs, IRAs, government TSP etc.), then the Roths. Next, I see if it makes sense to reorder investments. Some clients have interest-paying assets predominantly in their taxable accounts. A simple reordering of investments to exploit low-dividend/cap gains tax rates can save big bucks.

Next, I analyze asset allocation. Given your risk-tolerance questionnaire (I pray a couple is somewhat compatible) and other information I've gathered, I come up with a recommended allocation of percentage invested in stocks, bonds, and cash. I like to frame it in terms of the seven models offered by Schwab, ranging from most aggressive to least aggressive. I next look at all investments and figure out actual allocation.

Sometimes people are pretty much all in cash. They may have been spooked by 2008 for example. In any event, we discuss the recommended allocation. I explain that this is a long-term process, that we are moving into choppy waters, and the idea is to get comfortable with a plan and stick with it. For those contributing to their 401ks, etc., I explain that it is beneficial for markets to drop because then assets are cheaper.

Once I've drilled down to the asset level, I am looking for index funds with low-management fees rather than high turnover, actively managed funds with high expense ratios. I am interested in broad market participation in domestic markets as well as international markets. In the bond area, in today's markets, I am recommending shorter-term funds, some high-yield exposure as well as international bond funds. With rates so low, it is risky just to buy the broad bond market.

The second and, typically, last meeting goes over the recommendations in detail. I am looking to see whether you can carry out the investment plan. If I feel you can't, or don't want to, I'll offer to manage your investments at a rate of 0.4% of market value. As part of the meeting, we talk about monitoring the portfolio and rebalancing. I typically rebalance if a sector is 5% out of balance. We talk about the resources you have available at your broker/401k provider. For example, Schwab has portfolio analytics available to clients that makes the process very simple. In fact, they are currently testing a portfolio performance system that will soon be available.

In the second meeting, I also make recommendations in other areas in your financial planning you may lack. For example, you may need umbrella insurance, a will, or tax work. As a fee-only registered investment advisor, I am compensated by my clients--I receive no referral fees. If I receive referrals from someone I refer you to, I disclose it.

If you are several years away from retiring, it is very useful to begin thinking about where your income will be coming from and how much you will need in retirement. If in retirement, it is critical to think through when to take Social Security and how you will manage your assets to ensure you don't run out of money.

I'll leave you with recommended readings and blogs to follow. From time-to-time, I'll check up on you.

Generally, it's a pretty pain-free process. Not at all like going to the dentist!

Are You Over 70 and 1/2?

If you are over 70 and 1/2 or have inherited an IRA you need to take a required minimum distribution (RMD) before year end.

A calculator is at

http://apps.finra.org/Calcs/1/RMD

The RMD rules apply to all employer sponsored retirement plans, including
profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.

The RMD rules also apply to Roth 401(k) accounts. However, the RMD rules do not apply to Roth IRAs while the owner is alive. (Source: IRS)

Failure to take the RMD before year-end will result in a 50% tax.

A Few Minutes Can be Worth Big Bucks

Ed Slott is the #1 expert on IRAs. He is on public television whenever they are in their fund-raising period and has written several excellent books on retirement issues of interest to DIY Investors. If you know someone who has just turned 70, inherited an IRA, is trying to lower the value of their estate, or even wondering about their beneficiary designations, this year-end check list is valuable.

I suggest that, if some of these issues are applicable, you may want to consult a professional. For example, retitling an inherited IRA is tricky and even many bankers get it wrong and, thereby, end up generating a big tax bill.

Ed Slott Year End Checklist

Disclosure: I am not associated with Ed Slott and receive no compensation for any recommendations on this page. Post is solely for informational purposes.

E* Trade Wisecracking Baby

If you're like me, you pay a little more attention when new Geico and E*Trade wisecracking baby ads come on. In fact, there have been times when, sadly, they have been the best part of a Sunday afternoon of football - especially if you live in the Washington D.C. area.

Anyways, you may have wondered what filters through the mind of a financial planner type as he or she views the baby dissing the family dog for not warning that the parent was coming to take his laptop or tablet in his "timeout."

Well, maybe you didn't wonder; but anyways.

The financial planner is figuring how old the baby is. I'm guessing the baby is 3 years old. And, obviously, the baby is earning a lot for the commercial. If the baby opens up a Roth IRA and deposits $5,000 (you need at least $5,000 in income to do this) and can make 8%/year, then in 62 years the baby will have approximately $590,000 from this one investment. Think of doing this for 3 or more years and you see the possibilities.

What to invest in? Maybe buy 107 shares of EEM - the emerging markets ETF to begin with.

For those who have been living in a cave and haven't seen the E*Trade baby, here is a link.

When an Advisor May Not Be Acting in Your Best Interest

Fee-only registered investment advisors like to puff themselves up and proclaim how they are different from brokers. They emphasize that they are fiduciaries: they are "on the same side of the table as their clients". Really?

Many also manage assets. In fact, managing assets is typically their primary profit center. Watch them closely when they ask you how much in total assets you have to be managed. You'll notice their eyes narrow a bit and their lips purse out somewhat as their brains mentally calculate what they'll make off of you.

Let's break it down in simple terms. If an advisor charges 1% of assets (this is at the lower end), then he gets $10,000/year to manage $1.0 million. If you buy an annuity for $500,000, say, then obviously his compensation (his annuity, you might say)is cut in half to $5,000/year.

For many clients, handing over all of their money to be managed in the risky asset markets is not in their best interest. It is, however, clearly in the interest of the advisor.

In fact, we know from surveys that the number one fear of retirees is that they will run out of money. In most instances, it is why people do a financial plan in the first place. To alleviate this fear, the planner should, as a fiduciary, show people how to intelligently buy an annuity.

The bottom line is that people may want to separate the financial planning function and asset management function. At least then they'll know incentives aren't misaligned.

Related post: http://rwinvesting.blogspot.com/2010/07/single-pay-immediate-annuity.html