129: Modular Financial Planning 07: Saving and Investing for Retirement

[00:00:00] Intro: Do you think money takes up more life space than it should? On this show, we discuss with and share stories from artists, authors, entrepreneurs, and advisors about how they mindfully minimize the time and energies. Spent thinking about money. Join your host, Jonathan DeYoe, and learn how to put money in its place and get more out of life.

[00:00:33] Jonathan DeYoe: Hey there. Welcome back to Mindful Money. We are in the middle, towards sort of two thirds in to describing the Mindful Money modular financial planning process. I. Last time we talked about the importance of eliminating high interest debt, which can be a cancer on your personal finances. Too much debt can ruin a savings habit, drain an emergency fund, and overwhelm you with feelings of guilt and shame.

[00:00:56] If you have not paid off your high interest debt, then focus on that before [00:01:00] you engage in today’s, , advice, which is saving and investing for retirement. This episode is the seventh in our 10 part series, which covers everything you need to know to getting started creating your modular financial plan.

[00:01:15] Even if you love working financial independence, which is what we’re talking about here, is probably your ultimate financial goal. , I define financial dependence simply as the ability to live comfortably on your own terms, working or not. It’s the idea of choosing, this used to be called retirement, and it was defined as that point in life where you transition from.

[00:01:39] Working while saving a portion of your income to not working while augmenting your fixed income sources, social security, pension, rents, royalties, et cetera, with your savings. The reason saving and investing for retirement is important is that we all. End up filling the gap between our fixed income [00:02:00] sources and our total spending by withdrawing from our savings and our portfolios today.

[00:02:06] There are as many definitions of retirement as there are people retiring. Here are just a few of the variables that every retirees gotta. Consider.

[00:02:15] First, the age of retirement, the fire movement, the Finn Independent Retire Early Movement would suggest earlier is better, but if work is more than just a financial transaction for you, then this is probably less true.

[00:02:29] Second, will you work or not in retirement? About one third of the clients I’ve worked with find some form of compensated work to do in retirement. Not because they have to, but because they want to. Third living arrangements. Will you stay where you are downsize, move across the country, move closer to the kids, grandkids, look into retirement communities, or consider each of these sort of, you know, as you stage through retirement, I.

[00:02:55] Fourth, you wanna look at lifestyles and hobbies. It’s not enough to retire from [00:03:00] work. You must retire to something, hopefully something that engages you fully and creates a continued purpose for you. Another big question is when to take Social Security. So popular wisdom is to wait as long as you can to take social Security income, but your mileage may vary, , , for those people who look at taking social security, , or drawing from your.

[00:03:21] Investments, which may be yielding a pretty good return. You may not. You may want to take social security early and protect your investments. , it can be a trade off. , another issue is healthcare. This becomes really important if you retire before you qualify for Medicare. Long-term care is also often a concern.

[00:03:39] Travel will your spending go up for a period of time because , , your time freedom enables you to visit all the places you couldn’t while you were working. Really important relationships. You know, how will you stay connected to the friends and family that are so critical to your happiness as you age?

[00:03:56] Make this a formal written process. It’s probably the most [00:04:00] important ingredient of a successful retirement. So how each of us answers these questions is gonna vary widely. What won’t vary widely is the path that leads us to the opportunity to make the choices. Once you’ve laid your financial foundation, developed your vision of the future, adopted the savings habit built in the emergency fund, and put any high interest debt in the , rear view mirror, it’s time to start putting your dollars to work.

[00:04:27] Social security and a pile of cash are not enough to sustain your standard of living later in life. So you must starting as young as possible, save and invest for retirement. This is not an, it’d be nice to do thing. This is a must do thing. This is the first of two of these , in this conversation today.

[00:04:48] Today the stakes are higher than ever before. People are living longer. Gallup reports that the average retirement age in the US is 62 years old. Mortality tables suggest that the [00:05:00] average joint life expectancy of a married heterosexual couple is 92. Meaning that there is a 50% chance that at least one of the two people in the couple will require an income.

[00:05:12] Beyond their 92nd birthday for a male couple, it’ll be a little shorter for a female couple, a little bit longer. It is conceivable that you will need to plan on a retirement income that lasts well beyond 30 years. Even if you work in retirement, this can only postpone the need to draw on your resources.

[00:05:33] Pensions are basically a thing of the past. A combination of new technologies and ageism puts a big question mark next to your ability to work into advanced age. We could easily find ourselves out of the workforce sooner than we expect. So retirement income planning is something many people put off longer than they should.

[00:05:51] Retirement seems so far away or for some impossible, and there are simply too many fun things that attract our spending dollars [00:06:00] today. Do not let this be you. I. The best time to start saving and investing for retirement was a long time ago. , the next best time is today. So the best strategy for achieving a comfortable retirement is to start saving and investing for retirement as early in life as possible.

[00:06:16] This, however means more than just establishing a regular savings plan. Determining what trade-offs you’re willing to make and making them is an important factor in holding back lifestyle creep and upholding the savings plan, , which is critical to your financial success. So thanks to the power of compounding, every dollar you save or don’t save will be magnified by a factor of 10, 20, 50, or more in the future.

[00:06:44] Consciously weigh the trade-offs. You’re making every time you choose to spend money to support your present day lifestyle, including how often you go out to eat, , the school you send your kids to, the kind of car you drive, and the zip code where you live. [00:07:00] Your retirement income is literally the final trade off in your financial life.

[00:07:06] All the financial choices you make during a lifetime of earning, spending, , investing and giving will ultimately affect your retirement income. To begin thinking about this step, we have to learn to mind the gap. Retirement now lasts so long. It kind of amounts to a second career. It’s a long time to live without a monthly paycheck.

[00:07:26] You need to save enough to replace your monthly paycheck today, but also cover , those same monthly expenses as they inexorably rise due to inflation for a period of time. That is always unknown at the start. To do this, we begin by identifying the fixed sources you expect to receive in retirement, social security, , spousal support, annual family gifts, pension income, and any rents or royalties you have.

[00:07:53] Then you take a hard look at your annual expenses. They should include everything, your current spending, , anything you [00:08:00] plan on adding to your spending to sort of enhance your lifestyle in retirement, include. Everything from the water bill to your, , museum memberships, to property taxes, to travel and entertainment.

[00:08:10] Don’t forget to include expected income taxes. The difference between your fixed income sources and your living expenses is the gap your retirement savings must fill. And know this inflation will cause the gap to widen every subsequent year. Inflation that makes the retirement income calculation so complex your retirement portfolio needs to grow enough to both provide a current income stream and increase the principle in order to spin off an ever larger income stream the next year and every subsequent year.

[00:08:47] This rising income stream is also, remember there was one of these, this is the second one of these. The rising income stream is also not a nice to have. It’s a must have if you start drawing on [00:09:00] your resources when they are less than 20 times the amount you draw. Then you are on the road to running out 20 times implies a 5% withdrawal rate.

[00:09:11] Most research suggests that anything over a 4.5% withdrawal rate carries a risk of running out. Whatever your gap is, you can multiply that number by 20 or 25 to figure out your enough retirement portfolio. 25 times implies a 4% withdrawal rate. 20 times implies a 5% withdrawal rate. The higher your withdrawal rate, the more likely you are spending from principle.

[00:09:38] The more you spend from principle, the more likely you run out. Spending from principle is dangerous, so you want maintain as low as possible. You know, four, three and a half, 4%, , withdrawal rate. So the enough portfolio combined with the right investments, which I would suggest, , has an , emphasis on owning [00:10:00] the diversified shares of the great businesses of the US and the world, combined with an emergency fund and some appropriate income management rules.

[00:10:09] This is designed to grow income to pace inflation without going too deeply into principle, this combination will leave you. Near the end of your life with the largest asset base you’ve ever had while throughout your life providing that rising, , level of income. So neither a longer than expected lifetime, nor expensive medical care at the end of your life will overwhelm such a portfolio in such a plan as an added benefit, the noble stewardship of money.

[00:10:39] To create this rising income in this way. Also, endows a legacy that can be left for future generations and philanthropy if that’s your interest.

[00:10:49] Once you know the size of the enough portfolio, you can ask the question, how much should I save to get there? How much do I need to save to get there? It’s always a good idea to actually do the [00:11:00] math, to figure out how much you need to save to reach your retirement, your real retirement income goals, and maybe you aren’t ready to be that comprehensive about it and just need a starting point.

[00:11:08] If that’s the case, then you can start by having a set dollar amount automatically withdrawn from every paycheck. You know, a savings rate of 10 to 15% of your salary is commonly recommended, but nothing has to keep you from trying to save more, 20%, 30% the more you save. The more quickly you will be financially independent and able to retire.

[00:11:28] Now, if you want to create a simple retirement plan that helps you figure out the enough amount and tells you how much you need to save to get there, please download the Mindful Retirement Plan calculator in the show notes.

[00:11:41] You know what enough looks like and you know how much you need to save.

[00:11:45] Now, once you know these two things, where do you put your retirement savings? For most folks, the easiest way to save retirement is through an employer sponsored retirement plan. This is a 401k, 4 0 3 B, et cetera. if you don’t have access to such a plan, a [00:12:00] self-directed individual retirement account or IRA can be your starting point.

[00:12:04] These are the best long-term retirement savings vehicles because of their tax benefits. So deferring money directly out of your paycheck into your workplace retirement plan is a great way to reduce your current income tax. And depending on income amounts, you may also be able to fund a traditional or Roth IRA.

[00:12:21] In the traditional 401k plans, , and the traditional IRA, you get an immediate tax benefit, a deduction for the contributions, and your money grows tax free, but you’ll have to pay taxes once you begin withdrawing the funds. A Roth IRA or a Roth 401k, you do not get that immediate tax deduction, but your money still grows tax free and you won’t owe any tax upon withdrawals.

[00:12:47] So the best choice, traditional versus Roth depends on your tax bracket today versus your tax bracket when you are withdrawing from these retirement accounts. For most of [00:13:00] us traditional IRA and 4 0 1 Ks are the way to go to be certain. In your circumstance, you’re gonna wanna talk to a financial planner that can do some lifetime income projections to take a look at this.

[00:13:11] And future income tax rates are really anyone’s guests, , there’s a little bit of science to it, but there’s also a little bit of art. So if your employer matches your 401k contributions, then you’ve gotta contribute enough to earn the full employer match. The match is free money for your retirement.

[00:13:25] We’ve said it before. So with or without an employer match, the real goal should be to contribute the maximum amount allowable every single year. , so the annual 401k contribution limit in 2024 is $23,000. If you’re 50 years old, you can contribute an additional, , 7,500. This is your annual catchup contribution.

[00:13:46] Now, these numbers change a little bit every year, 500 bucks or a thousand bucks every year. , they go up. , and that’s, , government giving us inflation adjusted ability to, contribute to our 4 0 1 ks. Once you’ve maxed out your 401k contributions and an IRA are [00:14:00] Roth, assuming you’re within income limits, consider saving more into a taxable account.

[00:14:05] If you don’t have access to 401k through your job, just start by funding a traditional, Roth IRA maximum contribution in 2024 to a Roth or traditional IRA is $7,000 plus 1000. If you’re older than 50 years old, that’s your catch up contribution for an IRA and save excess into that taxable investment account.

[00:14:23] If you’re self-employed, you can also consider, , retirement plans like, , SEP IRAs, the self-employed pension, SEP, SEP IRAs, and individual 4 0 1 Ks. , there’s an old structure called a Keo that I, I haven’t seen for a while, but there’s people that used to use those as well. They’ve basically been replaced by SEP IRAs.

[00:14:40] , these are designed specifically for self-employed savers. So once you establish your retirement accounts. You need to invest them. So here are some investing basics. The most powerful tool you have is compounding, and the only variable you control when it comes to compounding is time. I. [00:15:00] You can’t increase performance without taking on additional risk, but you can give your portfolio more time.

[00:15:06] The earlier you start, the longer you work, and the more you save, the greater the odds you can retire When you’d like, the greater the odds, your money will outlive you and that you can leave a legacy for the people you love and the causes you care about. After you’re gone.

[00:15:22] Once you’ve saved money into a retirement account, the question becomes what are you going to invest in?

[00:15:27] Almost everyone makes this more complex than it needs to be. We recommend four simple investment practices, all of which you can easily research and apply on your own. They are one plan appropriate asset allocation. Two, broad global diversification, three regular rebalancing, and four. Maintaining low costs.

[00:15:56] So there are only two different kinds of [00:16:00] investments. I know that that’s gonna sound shocking. There’s only two things you can invest in. You can be an owner, you know, owning shares, and this is unpredictable in the short term, with better returns in the long term. Or you can be a loaner. So lending.

[00:16:14] Usually it’s a predictable fixed return. In the short term and lower long term returns, you know, there’s less compounding available. So what do I mean by owning? You can own your own company, you can own real estate, you can own broadly diversified portfolios of the great businesses of the US and the world.

[00:16:31] Owning is where you will discover the bulk of the return you need to keep up with and outpace inflation. The downside of ownership is more unpredictable returns in the short term. Another way of saying higher volatility, so what do I mean by lending? Lending is the same thing as buying bonds or other fixed income securities, CDs, et cetera.

[00:16:54] Fixed income provides a more stable ride in most environments, 2022, , [00:17:00] being a notable exception, but usually comes with less attractive returns that lose pace to inflation over time. So most people will own both. , they will both be owners and lenders. Owners and loaners. But the question will be, how much of your portfolio you subject to business ownership’s greater volatility in the short term to take advantage of business ownerships greater return in the long term?

[00:17:27] This is not a question of trading into or out of. Owning businesses or owning real estate. This is a commitment of a percentage of your portfolio to owning the shares of great businesses in the US and the world today and forever. Regardless of headlines or future economic commentary, the greater the percentage of your portfolio you commit to owning businesses, the higher their probability.

[00:17:52] Approaching certainty over time that your portfolio will first keep pace with and then [00:18:00] exceed the drag of inflation on your long-term. Spending power, this is the hard part. How much of your portfolio will you commit to owning these great businesses equities? For simplicity, we suggest you consider a minimum of 40%.

[00:18:17] Obviously a maximum of a hundred percent in increments of 20%. So maybe , you’re very conservative and you wanna own 40% of your portfolio in, ownership of the great businesses of the US and the world. Or it could be 60% or 80% or a hundred percent. The higher percentage of equities, the higher your long-term return expectations, but the less predictable your returns will be in the short term.

[00:18:40] Once you know the percentage of your portfolio you are committing to owning, , shares in the great businesses of the US and the world, the rest is really easy. For your equities. Don’t overthink this. You wanna own a global market index or a combination of geographic indices that roughly mimics the global market [00:19:00] index.

[00:19:00] Personally, I have two different buckets. In one bucket, I own a single global. All cap growth value everywhere. , portfolio that has everything in it. And then the second bucket is a bucket. I split between three geographies. There’s a domestic geography, that’s USA, there’s a developed international X-X-U-S-A geography that’s basically Europe and Japan.

[00:19:25] And then there’s an emerging markets geography. And I own the broadest, cheapest available index of these, , companies. You can look to Schwab or Fidelity or iShares or State Street or Dimensional Fund advisors among others for low cost broad index, , portfolios. , if you’d like, you can further split these geographic areas between growth and value or between small, medium and large.

[00:19:49] , you could even try your hand at picking individual, , stocks. But especially if you’re doing this yourself, I would not pursue a more granular investment selection process. [00:20:00] Fortunately, you don’t have to be a Wall Street market whiz to successfully invest your retirement assets. The best bet is to keep it simple.

[00:20:08] If you live within your means, start saving and investing early, and commit the preponderance of your portfolio to owning diversified shares of the great companies of the US in the world. Then a secure, happy retirement. Whatever that means to you can be yours.

[00:20:23] As always, thanks for listening. If you want more on how to invest your retirement savings, I recommend checking out the 10 episodes, , of the Mindful Money Podcast, where I discuss and dispel the gathering darkness.

[00:20:36] They start with episode 91 and go through episode 100, and they fully explain my belief in and commitment to owning shares of great businesses as the perfect tool for your lifetime of investing. Next time, I look forward to discussing whether you should pay down low interest debt. Or increase taxable savings when you have a little bit of extra, , money on the side.

[00:20:55] So again, thanks for listening and we’ll see you next time.

[00:20:58] Outro: [00:21:00] Thanks for listening. Full show notes for each episode, which includes a summary, key takeaways, quotes, and any resources mentioned are available at Mindful Money. Be sure to follow and subscribe wherever you listen to your favorite podcast. And if you’re enjoying the content and getting value from these episodes, please leave us a rating and review ratethispodcast.com/mindfulmoney. We’ll be sure to read those out on future episodes.