Planning for Retirement
All right, here we are wrapping it all up with our eyes towards the future, eye on the prize of retiring at some point. But we have to be taking some actionable steps now here today in order to set ourselves up in the future. So how to plan for retirement even if you feel that it's not important right now, 'cause that is definitely one of the excuses that we use when it comes to thinking about the future, and we will actually get towards wrapping up today talking about how to mentally get yourself over that thought process. But first, I'm actually gonna start it out a little dark, with the bleak outlook on retirement for millennials, which actually does feed into some Gen X-ers and certainly our upcoming Gen Z-ers as well. And then what to look for in a retirement account. We really are gonna dig into some of the nitty gritty here today, so do please feel free to join in, those of you here with me in the studio, ask your questions when you need to. Those of you who are tuning in, pleas...
e sound off in the chatroom, ask your questions. Like I said, some of this is gonna get a bit technical, but it's important, so I want to make sure that we're all on the same page, speaking the same language. Then we're going to talk about knowing your time horizon risk tolerance, which is a very gentle way for me to say we're gonna talk about some investing terms. We're also going to analyze what to do if you're self-employed and you do not have a 401(k) or a 403(b) or a pension, do those even exist any more, at work. Then, the actual technical ways to go about setting up your retirement account. What do you do when you finally open it up and you're faced with all of these words and terms you have no idea what they mean? And then what happens when you leave your job? Let's be honest, most of us are not going to be company men and women our entire lives. We probably will move around at some point, you're gonna hop from job to job. So what do you do if you had a 401(k) at an old employer and you're going to work for somebody new, where is that gonna go? And finally, some secrets to actually feel motivated to save. Now if you've been with me for the whole boot camp you remember back in the savings segment, we talked about a couple of different mind tricks and hacks that you can use to motivate yourself or even trick yourself, protect yourself, however you wanna think about it, and I teased then and there that there's one more way that I want you to think about feeling motivated to save, that I was holding out for the retirement section, so we're finally gonna get into that here at the end of our class today. But first, talking about this bleak outlook on retirement, and you know, I'm sorry to be a downer starting out on this very important topic, but I do want to address some of the fears that we have when it comes to retirement planning. You know, 65 has really traditionally been the old rule of thumb, but surveys and studies that have come out of the millennial generation thinks that we won't be able to retire until we're 72 to 75 years old. That's a long time. Sure, we may be living longer than previous generations, we'll see, but that's really old. I don't know about you, but I don't wanna wait until that point in my life to do some of the things I love and wanna do.
Do 'em now.
You could do them now, that's true. But you also have to have money in order to be able to do them now. And we're gonna dig into that, and part of that's with this idea of financial independence formula. Now this idea, I'm gonna take it very slowly and kind of deconstruct what all of this means. But the financial independence formula is the amount of money that you need in order to safely be able to opt out of getting a paycheck from an employer, or at least for a period of time. Now the way it breaks down is you have to figure out how much you need per year, and by that I mean if it's just you, if it's you and a family, if it's you and a spouse, how much do you need to pay all of your bills, have health insurance covered, live the lifestyle you wanna live, and survive. Everybody's gonna have a different number here, and it also depends on at what age you plan to retire, too. That's really going to be a big part of this conversation. But for the sake of argument, I'm saying you need $60,000 for a year to live comfortably at the lifestyle that you want. Now, the other thing to know is this idea of a safe withdrawal rate. Now, this is something you can also look up and read more about after this class today, but a safe withdrawal rate is essentially the number, the percentage of your portfolio that you can pull out every year without outliving your money. Now, typically the number that has gotten used for about the past 15 to 20 years is this idea of 4%. If you only pull 4% out of your investment, your retirement portfolio, you're not going to outlive your money, the concept basically being your investments will keep growing and compounding, all terms we're gonna talk about here today, and you're not gonna outlive it. And that equals your FI number. So in reality, let's say $60,000 divided by 4%, that means you need about $1.5 million to consider yourself financially independent and to be able to no longer have to earn money, you can just live off the money you have both saved and invested. Now, some people would want to be more conservative with that safe withdrawal number, and maybe play around with 2.5 or 3%. It depends on the age in which they plan to retire and their risk tolerance in general, and how much money they wanna have saved. But I just want you to familiarize yourself with this formula, because you're gonna hear, especially if you start to read more about retirement, learn more about retirement, this idea of an FI number, a financial independence number, that's what the formula is. That's also a fun thing to kinda play around with yourself, this idea of how much do I need in order to live off of year to year, and how much do I have to have saved in order to be able to retire? This is how people get that number. Now, if you want to get really freaked out. (laughing) By 30, you are supposed to have one times your annual salary saved for retirement. We actually talked about this in the very beginning of the boot camp, the point of talking about benchmarks. And that is why I'm bringing this up. I am not bringing this up to stress you out or to shame you or to make you feel bad, I'm bringing it up because we humans intrinsically love to compare ourselves to other people. And if you wanna compare yourself against a benchmark, this is one that financial professionals used. This is a way for them to say hey, you're on the right path. Now, if you're not there, that is also okay. You have time, you can just start working towards getting these kind of goals now, but by 35, you are supposed to have two times your salary saved. So if you haven't gotten started, I do want you to think about ways you can actually start taking steps to get here. But again, I'm kind of playing on this idea of bleak outlook for millennials a little bit up top, we're gonna come back around and cheer up in a minute and I don't want to shame or make anyone upset, but these are the goals, these are the benchmarks. If you're not there, that's okay, but I want you to start working towards getting here. And again, it's your annual salary. So if at 30 you're making $40,000, that's how much they would like to see in your retirement savings account. Not just savings across the board, specifically your retirement savings. So again, like I was saying, if you're earning $55,000 and you're 30, then it's $55,000 saved, and by 35 they want 110. But here's the reality. So these stats actually come from Q2 of this year, 2018, a Fidelity analysis found the average retirement savings to be in a 401(k) $104,000, in an IRA $106,900, and in a 403(b), which if you're not familiar with that term, it's basically a 401(k) for nonprofit companies, $83,400. And this is based off of more than 30 million retirement accounts in the United States. So sure, there are probably some young millennials, older Gen Z-ers who are very early in their careers, might only have $4,000 saved for retirement, and maybe that's pulling down the number a little bit, but you gotta think, this is across 30 million retirement accounts across a wide variety of ages, so truly, a lot of Americans are not at all on track to prepare for their own retirement. And that is a very common problem in our country right now, which is a big part of the reason why I wanted to end this whole boot camp talking about this, because you, if you really wanna get your financial life together, you also wanna be protecting your financial future. And one of the ways we can do this is by preparing for retirement. And I generally believe that fear and confusion is a real part of this problem. We really use and kind of scapegoat this idea of wage stagnation and student loans and the other forces in our lives that could make it hard for us to have money to put aside to save for retirement, but I think a big part of the problem is that we are afraid and we are confused. Because there's a misnomer I want to debunk right now, and that's we use the term saving for retirement, but truly you are investing for retirement. You want to be putting your money into investments. Now, I will continue to say save for retirement because I know that's what we generally use and it's the common vernacular, but investing is what I want you to be doing, and that's why I think a lot of us get scared and confused. One, you might be intimidated by the stock market. You might have a negative reaction to the idea of investing, maybe you perceive it to be gambling, maybe you grew up around 2008 and the great recession made you really nervous, maybe your parents or your grandparents lost a lot of money at that time. Maybe you personally have already lost money in the stock market, and that's why it just freaks you out. For others, you're just straight up confused. I remember the first time I had access to a 401(k) plan, I logged in and I was all excited to take control, and then I saw these terms like big cap, small cap, Dodge & Cox, I had no idea what any of this meant and I just clicked out and walked away, because I was confused, and then I was a little bit embarrassed about where do I turn to for help on this? So we are gonna be digging into all of that here today. But first I want to get into the very important idea of compound interest, and why this matters so much. One of my favorite money quotes ever is "Compound interest is the eighth wonder of the world. "He who understand it, earns it. "he who doesn't, pays it." It is often attributed to Albert Einstein, who knows if he actually said it, but it's a great quote. And the reason it's so powerful is because those of us who have ever dealt with credit card debt, student loan debt, have been on the wrong side of compound interest. You understand what it feels like that every single time you make a payment towards your debt and it just seems to never go down, it's because interest is working against you. But on the flip side, especially when it comes to investing, it can be working for you. And it's this simple concept of earning interest on your interest. So to oversimplistically break it down, this is a very, very simple explanation, but if in year one you invested $100 and you earned a 5% return, you have $105 at the end of the year. Now in year two, you're going to continue to earn interest on that whole $105, not just on the initial $100 you invested. You're earning interest on the interest you already earned. So at the end of that, you got an 8% return, so now you have $113.40, and then you're gonna keep earning more interest, and it's going to snowball. Now, does that sound like a lot of money? No, but if you start to deal with tens of thousands to hundreds of thousands of dollars, think of how that can be snowballing for you. So you're constantly earning interest on your interest. Now, I'm gonna break it down with a real life example. First we have Lily. She decided to start saving into her 401(k) when she was and she first had access to a 401(k) account. She decided to put $400 per month, so $200 out of each paycheck, into her 401(k). Now her husband Marshall put off saving into his 401(k) until he was 35. You know what, he's feeling a little competitive, he wants to catch up with his wife, so he started to double down and put away $800 a month into his 401(k). They both have decided they want to try to retire at 65, and they received an average percent, or an average return of 7%. What that means is over the course of all of the decades they've been invested into the stock market, on average, they've received a 7% return on their investment. So some years were high, some years were low, but across the board it's about seven. So here's how this actually shakes out. Lily, with her 7% return on $400 a month for 40 years, has just shy of $960,000 in her 401(k). Now remember, her husband Marshall doubled down and put $800 a month away, but waited 10 years. So he only had 30 years to get his returns. And he did not even catch up. He had over, just a bit over $900,000. And part of the point here is that if you wait to start, even if you double down, you're not necessarily going to catch up, and that's why I'm harping right now on this importance of starting early and being consistent. And also consider that these are two people who in this very simplistic example, this very simplistic formula, never started putting more away. Well, you would think that, I'm sure they got raises over the course of their careers, they started to eventually put more away, so they would've gotten even more. They would've probably had well north of a million dollars individually, so this is just a very easy simplistic explanation, and they still both got very close to having a million dollars saved by being consistent.
In the slide where there is, like, people that were saving for, and their 401(k) and the people that were saving in their IRA and 403, could there be some crossover in some of those categories?
It could be, it's not terribly likely, because those are also being pulled from, since that's a company that does 401(k) programs for a lot of companies around the country, that that's pulling aggregate information. A lot of those folks probably aren't doubling down with an IRA and a 401(k), so I hear what you're saying, that maybe it's people who have both. I think that's probably a very small subsection of folks in there, and so yeah, even if they are, though, that's still only about $200,000 saved for retirement and some of those people are nearing retirement age and certainly don't have enough put away. But that's a great question. Now, part of what you're talking about also ties into your concept of retirement. The financial independence number is not meant to say you're never working again, but it does mean you have the option. So whether or not you want to still be working and earning an income, that's completely up to you, and I think a lot of us humans need utility. I agree that you should still be working in some capacity, no matter whether it's a job that you do yourself, if it's something you do for fun, we still need to be doing something, especially as you opt out of perhaps the traditional workforce. I think if you just kind of go off into the woods by yourself, that's a very lonely existence. We like to be around each other. That's a bit of a different conversation, but coming into this, too, where a financial planner can help you is also talking about things like insurance coverage for long-term health care, how you're figuring all those pieces of your financial plan out. So that is a time in your life where it does make sense to perhaps talk to an expert. I will also say sometimes those formulas are making baseline assumptions about things like you own a house and you've paid it off, so the cost of where you live is just maybe utilities and property taxes, but you're no longer paying a mortgage or paying rent. And that's why some people can live on less, because some of their base needs have actually already been covered in a very different way. So a lot of it is going to depend on the kind of life that you want to have. Some people even leave this country altogether, and move to another place where it's a much lower cost of living, maybe health care is a very different scenario, so it's a lot easier. So you have a ton of options. That formula is just really to get you thinking, which it did, and I'm glad it did. But you're right, there are so many different factors that tie into that, what is my lifestyle going to be? And it does have to evolve, especially if, for example, your family size is going to change and what you're expecting out of that, too.
Yeah, I think my biggest fear is, having worked with, the last couple years, with people who are having to do buy-ins for community centers, like where they have to pay not only a monthly fee for rent, like $5,000, but they also have to sell their home and pay $315,000 or have some sort of buy-in, is that I don't want to feel like, oh, I'm saving for retirement, and I'm really good, and then be like, oh, but I want to live in this community center where they have a kitchen and a food thing and it's all inclusive, and there's no way I could even do that, or that my health needs aren't necessarily taken care of 'cause all of a sudden I need assistance in some sort of community center, so yeah.
And part of that is risk tolerance, and that should certainly tie into your number, and you certainly should buffer as much of that in as makes you feel comfortable and confident. So perhaps your number is $5 million, and that's totally okay. That might be your financial independence number. There is nothing wrong with having a big FI number, but then it also helps you start to do the backwards planning, and that's the whole point of why I put the formula up and wanted you to start thinking about it, because without that overarching number in place, it's hard to actually figure out, well, how much do I need to be saving and investing every month in order to achieve it, and what do I need to be doing? So another part, just returning to Lily and Marshall as well, is this idea of, I said they'd invested that money. So if they had just saved that money, Lily only would've had about $192, as opposed to nearly a million dollars, and Marshall would have actually beaten Lily in this game and had just shy of $300,000, where he also had a bit above $900,000 by investing. And that's the reason I want to bring up this particular slide, is I mentioned it already. We always say save for retirement, and I think that that almost confuses us to think that we're not putting our money into the stock market. You do want to be investing for retirement. Now, if that makes you feel queasy, I heard a woman one time when I interviewed her gave me a marvelous quote that I love, and it's this idea that, all right, if you hate the stock market and you don't want to invest, fine. But you're going to save a whole heck of a lot more than somebody who does invest, because when you're investing, you're allowing your money to also do some of the heavy lifting for you. And that was such a great way to reframe it and think about it, and she's absolutely right. Her name is Jill Schlesinger, and I referenced her in my second book about investing. But I love that idea, because at $400 a month, with investing, Lily really set herself up for a comfortable retirement. But if she just saved it, she would've had to save a whole heck of a lot more in order to achieve the same result.