Increase Savings Rate By 1%

Jim Blankenship at Getting Your Financial Ducks In A Row has asked financial bloggers to encourage Americans to increase their savings rate by 1%.  This is important because the nation faces a looming retirement crisis.  Simply, Americans in the red zone of retirement, 10 - 15 years away, have inadequate savings to support themselves when they exit the work force.

There are numerous "tricks" one can use to increase savings that even the frugally challenged can easily adopt, and some of these are detailed by Jim and his contributors.  The one I offer may be a bit challenging; but, if you try it for a while, it will very likely become a habit, and your mid-60ish self one day will surely appreciate your meeting the challenge.

My Ideal Client

Recently I had lunch with an ideal client at the *Eichenkranz restaurant in Baltimore.  Ed insisted on paying.  But this isn't why he is an ideal client.  The reason is that when the check came, he pulled out a small, spiral notebook along with his glasses from his shirt pocket and carefully scanned the bill.  He then picked up a pen and carefully entered the amount in his notebook.

Surely I have to go no further to convince you that Ed has a really good handle on where his money goes.  This goes a long way towards making him an ideal client.  When we sit down and talk about spending and saving, Ed has the figures at hand and I know they are reliable.

I know all of this is old school, and most people today can more easily do all this with tablets and smart phones and whatnot.  Whatever works is fine.  Knowing where your money goes is the crucial first step in managing finances.

The Challenge

But how can this help increase saving and where is the challenge?  Simply, do the following for 30 days:  when you eat out, note the cost of soft drinks and record it in a notebook, like Ed, but order water.  In other words, record how much you are saving each time you eat out by not ordering a Coke or a Pepsi.

I know - this is a huge challenge for most people.  If, like many Americans, you eat out often and with your family, you'll find you save a decent amount; and you'll be surprised at how much you spend on soft drinks - and your dentist will commend you!

You might consider giving the kids the choice between a soft drink and receiving $1 in spending money.

All is for naught, of course, unless you bank the amount saved each month!  It isn't money for spending elsewhere!

Admittedly this isn't easy.  And, 30 days is obviously arbitrary.  To me, it is long enough to make it a challenge and get most people to turn the behavior into a habit.

Addendum

*If you are in Baltimore and interested in the ethnic experience along with really good, reasonably priced food, visit the Eichenkranz .  The drive there will take you through an area that will give you a strong flavor of industrial America.

The Proteus Effect and Saving

If you are interested in behavioral economics or the psychology of investor behavior, read Jason Zweig.  His book Your Money & Your Brain is the classic in this field.

In a thought-provoking article, "Want to Retire Wealthier? Start by Scanning Your Photo,"  in Tuesday's Wall Street Journal, he described the research being done using, of all things, avatars.  He reports that research being done at Stanford University enables people to see themselves at retirement age via their avatar. This, in turn, gets them to save more. The use of avatars has worked in the area of increasing confidence by giving people an attractive avatar in virtual reality space. The research suggests it can help people save.

Now DIY Investor is admittedly low tech. He doesn't deal with avatars and such. He doesn't even have, as far as he knows, an avatar. In his low-tech style, he merely reminds clients that one day they will wake up and it will be their 65th birthday and whether they have choices depends on their saving behavior today. It's hard to tell how effective this is.

Who knows? Maybe avatars are the key to getting people to focus on the long term. As the article points out, research by the Center for Retirement Research at Boston College finds that over 50% of Americans are not in a position to maintain their lifestyle in retirement.

Interestingly, some people already have the talent to think longer term without putting on the headset and going into virtual reality space.  Warren Buffett, for example, thinks about the value of spending on a haircut today compared to investing the money for 30 years. Most advisors dwell on the spending that takes place at life's big events and wonder whether people give them sufficient weight. DIY Investor tends to think, as well, that not understanding the basic concept of compound interest plays an important role in people spending significant amounts on weddings, funerals, and the first two years of college.

Mr. Zweig points out that one difficulty is that people don't know what they will want 30 or 40 years from now, and this is a hindrance to saving. DIY Investor suggests that perhaps a better way to think about it is in terms of what you don't want. This is a good place for a little Zen. DIY Investor doesn't want to work part-time for Walmart.

One of the psychologists, Dan Goldstein,  working at Stanford suggests putting employee's "age-morphed" photo on benefits section of company website. Great! Now we'll be even more depressed in down markets with statements showing how we'll look at 65. Admittedly, this isn't as big a deal for DIY Investor as it might be for some of his readers.

Building, Preserving and Keeping Enough Wealth for a Comfortable Retirement

Guest post from Charles Tran at www.creditdonkey.com:

We hear the dire predicaments from politicians and financial advisors alike: we simply cannot rely on Social Security to get us through retirement. We all know we must begin saving in order to guarantee a solid financial future after retirement, but not many of us know how to get there.

Today is the day to begin saving for your future. Thankfully, building, preserving and saving our wealth can be accomplished by following a number of strategies:

• Don’t save tomorrow what you can today – In the best case scenario, you start to save for retirement the moment you land your first job out of college. However, not many 20-somethings are thinking of retirement. The reality is that the sooner you begin saving, the better off you’ll be, even if you are able to only save small amounts. Remember: the key to building wealth is time. The more time you have, the more you can put the power of compound interest to work for you. There is a reason Albert Einstein said, “The most powerful force in the universe is compound interest.”

• Remain realistic when setting retirement goals – Regardless of what a financial advisor may tell you, only you know what you can comfortably afford to give to your retirement account each month. For example, you do not want to sacrifice your credit card payments to store away retirement funds, as the financial cost would not be wise. Setting unrealistic goals that you simply can’t keep is the quickest way to ensure your retirement plan will go down in flames.

• Absolutely take full advantage of your employer’s match – If you only employ one retirement strategy, then it should be to always match your employer’s maximum retirement contributions. The amount of money your employer will contribute to your retirement plan is essentially free money. If you neglect to contribute  the maximum employer contribution, you are really burning free money for your golden years.

• Think 401K or IRA for your retirement plans – Both 401K plans  (usually through your employer) and IRAs (individual retirement accounts) offer huge tax breaks. Put your money where it can grow without being overtaxed so you can reap the rewards of saving for retirement.

• Concentrate on stocks and go easy on the bonds – Generally speaking, stocks  are usually a smarter option for younger savers who have a higher risk tolerance. In fact, stocks achieve better over long periods than nearly any other type of investment. Bonds  are a challenge, though an option, especially for those near retirement. Those who are on fixed-income and vested in bonds will be sensitive to inflation.

• Dip into your taxable accounts once you hit retirement – The best way to make sure your retirement money will last is to draw from your taxable accounts and leave your tax-advantaged accounts alone so they can continue to earn you compound interest until the last possible minute.

• Consider the advantages of working part-time in retirement – If you are quickly nearing retirement age without a substantial nest egg, consider taking a part-time job. Making just a small amount of money can mean your retirement accounts will go that much farther. Do something you love or find something that interests you and earn some part-time cash to put toward your living expenses.

The prosperity of your golden years starts today. The sooner you begin to store away money for retirement, the larger your nest egg will grow.

Generating a Paycheck From Your Nest Egg

You are no longer an accumulator; you are now a decumulator. This is a completely new phase. It needs to be thought through carefully. Too often people retire in a rising market with no thought given to how they are to fund their retirement. Then the market drops and the problems start.

Think it through ahead of time. You are no longer building up your nest egg by making your 401k contribution out of your paycheck every two weeks. Now you are looking to the nest egg to provide a paycheck.

There are a number of ways to proceed. DIY Investor believes that the decumulator should first put 9 months of payments into a short-term fund. This is where the paycheck will come from. This is the primary defense against a market downturn. It enables you to weather a market drop.

It is important to have this plan in place to minimize the chances of selling stocks or bonds after they have dropped significantly in value. If you think about it, just systematically selling in a down market is the opposite of dollar cost averaging - the process that was so instrumental in building the portfolio up. Avoiding this "negative dollar cost averaging" is important in managing the nest egg in retirement.

Part 2 of the plan is to seek to structure the portfolio so that at least 60% of income needs is met by dividends and interest payments of the portfolio.

Here is a simple Excel table for one of my retired clients:

 CLICK TO ENLARGE  Note that this client only invests in ETFs. As an aside, for those seeking solid dividend paying stocks, there are blogs that do a lot of really good analysis on dividend stocks. For example, The Dividend Pig offers a list of stocks with an accompanying analysis along with a list of other bloggers who analyze dividend stocks.

In the table, notice the bottom line is in the right hand corner, $10,405. Divide this by .60 and get $17,341. This is the amount that the portfolio can easily provide and weather a market downturn. Also notice the portfolio yield, 2.42% which is key.

If $17,341 isn't sufficient, then more assets have to be directed to dividend paying stocks. That can be done, but always keep an eye on risk. Notice that in the portfolio above, DIY Investor could easily sell the small stock ETF and add a dividend ETF and at the same time reduce one type of risk. It, of course, reduces the expected return on the portfolio.

What are the dynamics? Simply, if the return on the overall portfolio is less than 7% (7% is a target return - it was the assumption used in figuring out if she had enough to retire on), feed the dividend and interest income into the short-term fund from which the paycheck is generated. Otherwise, if the return is higher, reinvest the proceeds. The IRAs, of course, present a challenge because their withdrawals will be taxed and they have to start to be withdrawn at 70 and 1/2.  But at this time, also, the yield on the portfolio will likely be higher because the allocation to bonds will be greater and probably yields will be higher. Still, it is worth thinking about.

The table shown above doesn't take long to do. If you are not familiar with Excel, find someone who is - possible a high school student.  Especially, if you are within 5 years of retirement, this will begin to give you a handle on meeting your income needs whether you use the strategy described here or one of your own.

Figure the Impact of Saving Your Payroll Tax Cut

Financial planners recommend upping the contribution to your qualified accounts (IRA, Roth IRA, or company 401k etc.) by the amount of this year's payroll tax cut. Admittedly, this isn't easy, now that food prices are rising and gasoline prices have spiked. Still, if possible, a 2% pickup in your personal saving rate can make a huge difference for many people. This is especially true for younger people, in light of the state of Social Security and its likely changes.

To quantify some of this, the New York Times "Savings Calculator" is a useful resource. You can see the inputs DIY Investor put into the calculator. DIY Investor assumed a $40,000/year income, 10% savings rate, 8% investment return, and a 20-year time horizon. This produced an end-of-period savings balance in inflation adjusted dollars of 

Source: New York Times

$333,549, as shown by the bottom line in the calculator's accompanying graph.

CLICK TO ENLARGE

Next DIY Investor assumed the savings rate was increased by 2%, by putting the payroll tax cut into savings. Keeping everything else the same produced an end-of -period savings balance of $393,735--an increase of approximately $60,000.

All of this translates into choices 20 years down the road. In real terms, it may make the difference between having to work another year and a half or having the flexibility to retire.

This is a useful tool, DIY Investor believes, for motivating young people to save for the future. The next few years will reveal how poorly this has been done by the "boomer" generation.

Number 1 Top Tip for Financially Safe Retirement

In "Top Ten Tips for a Financially Safe Retirement," Tim Begany lists "An Immediate Fixed Annuity" as number 1.

This is interesting because it is how you convert today's 401(k)s/IRAs etc. into your father's pension plan. In other words, there is no need to sit around whining that we no longer have pension plans like in the past.

It is interesting also in that most people who use a financial planner will never have had the option presented to them - even by fee-only RIAs who puff themselves up proclaiming their fiduciary status. Why is that? It is simple - if you put the money into an immediate pay fixed annuity, the RIA won't have the funds to invest for you; and investing your money is where they make their money.

Imagine people who retired in 2007, when yields were higher, and before the sharp downturn in the market. Instead of going through that traumatic experience with their retirement on the line, they could have locked in a lifetime income stream of payments greater than that available today. Shouldn't their financial planner have suggested this for at least a portion of their retirement assets?

Want $600/month for life?

Well, if you're 65 years old and have $100,000, that's what you can get with a single premium immediate pay annuity as discussed in this previous post. Experts now are debating whether this should be a standard option for individuals leaving a company.

In my view, it is an option that should be understood by every retiree. The number 1 fear of seniors, as shown in poll after poll, is running out of money; and, of course, a single premium immediate pay annuity is a way to eliminate this fear.

As it stands now, retirees can buy them on their own. They just need an education in the pros and cons of the product. This is what companies should provide. This is low cost and doesn't put the company in a fiduciary straight jacket. In fact, retired benefit specialists would probably do pro bono work to produce a national fact sheet that tells retirees exactly what they need to know and update a list of low cost, fiscally sound companies such as TIAA/CREF/Metropolitan Life etc. that retirees can go to.

Do you think this is a viable approach?

BrightScope Again

A tsunami of retirees is about to hit the beach. And they aren't in a position to retire. And it is going to get worse. A big part of the problem is that retirees have poorly structured 401ks that they aren't contributing enough to.

BrightScope is a service that has taken on the monumental task of rating 401ks relative to peer plans. Every 401k participant can now look up the rating of his or her plan by going to www.brightscope.com.

If your plan is not rated, you should go to your human resources person and request that it be rated. If it is rated, you should look at the component ratings to ensure that you have good choices in your investment menu and low costs for the plan. You will notice that the site allows you also to do a personalized analysis of the costs you are bearing. Again, if the ratings are not satisfactory, you should ask the plan administrator why.

For too long, the costs of plans has been opaque, as Wall Street has hidden the excessive fees it charges.

Plan administrators are fiduciaries. As such, they are legally bound to provide plan participants with appropriate investment choices and educate plan participants in the investment process.

Full disclosure: I use the BrightScope data in counseling pension plans and pension plan participants.

Work More Years, Increase Saving, Invest More Aggressively?

Yesterday's post was a question of which 3 events would impact an investor's nest egg the most under assumed conditions. The 3 events were: work an additional 2 years, increase savings rate from 8% to 10%, or increase return on assets from 6% to 8%.

Kevin at "Invest it Wisely" first guessed #3 - increase return, but then changed his answer to #2 - increase savings rate. Actually he was right the first time. Before everybody starts tsk tsking and thinking, "yeah, that's what always happens when you change your answer," actually behavioral scientists find that changing answers on tests (better known as second guessing) actually improves scores.

Anyways, for the example, the person will have a nest egg of $420,000 if he doesn't change his behavior. The respective options work as follows (according to "Fiduciary Benchmarks" data):

1. work 2 more years $490,000
2. Increase savings rate from 8% to 10% $540,000
3. Increase return from 6% to 8% $ 560,000.

What if all 3 options are taken? Then the nest egg would more than double to $850,000! It is worth pointing out that working extra years and increasing the savings rate are under the control of the person. For return, he is somewhat at the mercy of the market. It illustrates the importance of asset allocation. From a financial planners point of view, if the so-called "number" required for retirement was $800,000 or so, a bigger allocation to stocks would typically be recommended.

Do You Know Biggest Impact On Retirement Savings?

Adapted from Kiplingers 10/2010, chart 50, taken from Fiduciary Benchmarks.

A QUIZ:

First the assumptions:

-45 years old
-earning $50,000/year
-contributes 6% of pay and employer matches 50%
-investment return equals 6%/year
-retires at 65

Suppose he can do one of the following:
1. work 2 more years, i.e. until he is 67 years old,
2. increase saving rate from 6% to 10%,
3. increase return from 6%/year to 8%/year.

Which of the 3 do you think would have the biggest impact on his retirement savings?