Archives for May 1, 2019

Yesterday, JP Morgan Chase sparked Twitter rage when it tweeted (since deleted) the question: “why is my balance so low” and responded that people should be more mindful with their spending, by cutting out coffee, dining out, and short taxi rides. Chase may not be the best messenger, since its history of charging high fees to low-income customers is one reason their bank balance is low. It also pays executives, like CEO Jamie Dimon, lavish salaries. But the bank’s tone-deaf tweet contains some good advice.

Managing your personal finances is hard; even for experts it’s an extremely complex risk problem, one I’d argue that is harder than managing assets at a hedge fund. We must take our income today and make sure it lasts a lifetime, all without knowing how long we’ll live, what will happen to markets, if we’ll lose our job, if and when we’ll have an expensive health event, if we’ll divorce, or even a car break down. Life is full of uncertainties we must finance.

To make matters worse and unfair, the less money you have, the less margin you have for error. We all make financial mistakes from time to time, but the richer you are, the more you can afford to make them. The less money you have, the better you have to be with money. The risks are greater since low income people tend to have less comprehensive health insurance, cars more prone to breaking down, and lower incomes. It’s not only harder for them to save, they need more savings. And it’s not only low income people: 40% of American adults would have to take out debt or sell something to cover $400 in unexpected expenses, according to the Federal Reserve.

The smaller your income, the more every penny counts, which is why watching your budget and cutting down on small, unnecessary purchases that add up is great advice—even if it comes from someone who doesn’t have to make these same sacrifices. Mindful spending won’t make you rich like Jamie Dimon, it won’t combat income inequality, but that doesn’t mean it’s not a good idea. Perhaps America needs a more comprehensive social safety net instead, but until we have one, most Americans need more emergency savings.

Even before the Chase tweet there has been a curious backlash to advice that tells people to be mindful of spending, or to any financial literacy. The argument made by Washington Post columnist Helaine Olen, for example, is that because cutting out Starbucks won’t solve all your financial problems, admonitions to stop buying lattes is bad advice. Clearly, anyone who tells you the key to riches is eliminating spendy coffee is misleading you, but cutting out small, inexpensive luxuries may be the best insurance against a catastrophic financial event. Financial literacy also won’t make you rich. Many programs are not successful because they or poorly taught or don’t teach people what they need to know. But a well-targeted curriculum can help people be more mindful of their spending, increase saving, and be aware of financial predators—and those are all important skills.

Making your own coffee or improving your financial literacy won’t make you rich, but it will lower the odds you’ll be poor.

To those of us still working the 9-to-5, stories of people who retire in their 40s or even younger can read like a hero’s journey of mythic proportions.

But getting to that dream goal isn’t without its all-too-human regrets.

Learning what mistakes early retirees made on their path to retirement can help the rest of us avoid those same pitfalls, so we asked people who’ve done it what regrets they have about their path to financial independence.

Maybe because a goal of financial independence demands a focus on one’s finances, most of these early retirees’ regrets center on things less tangible than money. The financial piece is crucial — here’s more on the money aspect of how to retire early — but dealing with the intangibles may be even harder.

One note: You’ll see references to FIRE. That stands for “financial independence, retire early.” Awkward as the name is, the idea of financial independence is an important one. Many early retirees continue to work, but they choose how, where and when because they’re financially independent.

Here are five hard-earned lessons from early retirees:

1. Remember to have fun

It’s not easy to retire early. It’s likely you’ll have to drastically reduce your spending and ramp up your savings rate. But early retirees say money strategies shouldn’t be the only thing on your mind.

“My regret is that I was too focused on getting to the FIRE finish line,” says Carl Jensen, founder of the blog 1500Days.com. In 2017, at age 43, he retired early — with kids.

“When I was younger, I was dead-set on accumulating wealth,” Jensen says. He often worked 80 hours a week at his job, even as he and his wife flipped houses for profit, doing much of the remodeling work themselves.

“My 30s are a blur,” he says. “I expected early retirement to fix all of my problems, and then it didn’t.”

It took some time to learn that “happiness comes from within,” he says. “While FIRE has improved my life and I’d never go back to work, it didn’t increase my baseline level of happiness.”

No matter where you are in your journey, he adds, “Find lessons and value in the present.”

Jensen isn’t alone in this regret. Tanja Hester, who retired almost two years ago at age 38, has a similar story.

“When we first started getting serious about saving, I got a little bit obsessive about shopping with coupons,” says Hester, author of “Work Optional: Retire the Non-Penny-Pinching Way.” “I saved a ton of money on groceries, but it was so time-consuming and tedious to look for every possible best deal.”

Eventually, she decided it wasn’t worth it. Instead, she and her husband now strategize on cutting expenses. For example, they focus on big expenses, particularly housing and transportation.

“Don’t focus so much on saving that you don’t let yourself spend on things that you enjoy in the short term,” Hester says. “It’s just as important to enjoy your life now as it is to plan for a great future.”

2. Get a jump on saving and investing

Akaisha and Billy Kaderli, who currently live in Chapala, Mexico, retired when they were both 38 years old — that was 28 years ago.

If they had to do it all over again, they say they’d have gotten started even earlier.

“Neither of us came from families who knew about investing. We stumbled into it at the age of 30,” says Akaisha Kaderli, who co-authors RetireEarlyLifestyle.com with her husband.

Had they known about the power of compounding, she says, “we would have begun investing much sooner, and our nest egg would have been bigger.”

3. Don’t let the haters get you down

When the Kaderlis retired in 1991, the idea of leaving the workforce in your 30s was rare. Many of their friends and family didn’t approve. They regret letting that influence their happiness.

If they were doing it now, Akaisha says, “neither of us would let the opinions and judgments of family and friends influence our happiness about our new life path.”

“That, truly, was the hardest part,” she adds. “Going out on this journey alone, without their emotional blessing. We simply went forward anyway, creating our own path, and today, almost 30 years later, these friends are still working and trying to figure out how to retire.”

Even today there are early-retirement haters. Don’t listen to them. But do get your financial ducks in a row. Retiring early is doable, but not easy — here’s what it takes.

4. Take time to figure out what you’ll do now

Going from all work to no work is a serious lifestyle shift. The prospect might reasonably make you nervous — so nervous that you make many plans to keep busy. Think twice about that.

Pete Adeney, writer of the Mr. Money Mustache blog, says his big retirement regret was diving into a stressful and ambitious new real-estate business immediately after retiring at age 30.

“I thought it would be a dream hobby and not feel like real work, because it involved working on houses, which is what I used to do for fun,” he says. Not so much. On top of disagreements with his business partner, he ran into the housing crash of 2007.

“That left me holding an underwater house and renting it out for several years before I could eventually sell everything off,” Adeney says. “Lost a lot of time and money, and a longtime friend, but gained a lot of wisdom and appreciation for what I do and don’t want in my retirement life.”

Jillian Johnsrud, who became financially independent in 2015 at age 32, has a similar regret.

“It takes time to learn how to structure your day,” says Johnsrud, an author and speaker who blogs at MontanaMoneyAdventures.com. “No one feels great after bingeing on Netflix for 12 hours, especially the fifth day in a row,” she says.

She wishes she’d taken steps sooner to be involved in volunteering and other projects. “Instead, I had to start from scratch.” Now she and her husband find their days full. “It just took a few years into FIRE to figure out what that should look like.”

5. Embrace the conversation

Maybe you’re shy about your FIRE plan. Or maybe you’re laser-focused on the day-to-day financial challenge of retiring early. Consider taking a moment to talk with family and friends.

“I wish we would have spent more time talking as a couple about what we wanted this financial independence life to look like,” Johnsrud says. “We were good about planning the current year, but didn’t give much thought to our financial-independence lifestyle. It was more keeping our head down to save and invest.”

She also wishes she’d talked about financial independence with other people in her life.

“I regret not talking to my friends more about this. I would occasionally mention it almost in a whisper,” Johnsrud says. “It would be amazing if all my closest friends were also financially independent now. They could join us on our epic trips!”

Now that tax Opens a New Window. filing season has ended for most Americans, there is one step many might want to consider taking to prepare Opens a New Window. for next April.

This year was the first filing under the Tax Cuts and Jobs Act, which – along with new withholding tables – left some Americans confused about their refunds.

The average refund as of April 19 was $2,725. That is down 2.0 percent when compared with last year, when the average check was $2,780. The IRS doled out 95.7 million checks, but paid 1.7 percent, or about $4.4 billion, less in total refund dollars.

Some people voiced frustration regarding the size of their refunds this year, saying their checks shrank, while others even owed the IRS for the first time.

Nearly one in five, or 18 percent, of Americans owed additional money to cover their 2018 tax bill – 32 percent of whom said they received a refund last year.

Many taxpayers failed to check and adjust their withholding amounts, which caused at least some of the confusion. The IRS and Treasury Department repeatedly urged workers to do so throughout the year.

For those hoping to avoid an April tax surprise next year, the IRS has already begun encouraging people to check what is being withheld each week from their paychecks.

Additionally, it could be wise to get those finances in line now considering more potential issues could be on the way as the agency prepares to release a new W-4 form in time for next year’s filing season, which is expected to be more detailed than its current counterpart. The agency is hoping to get a more accurate read on what should be withheld from workers’ paychecks. If filled out incorrectly, however, workers could again be faced with a scenario where they are having incorrect amounts withheld.

It is worth noting that lower refunds indicate you did not overpay taxes during the year. Owing the IRS means you underpaid your tax obligations.

As a result of the new tax law, about 80 percent of filers were expected to see a net tax benefit. However, that could be reflected in higher take home pay instead of a large refund from the IRS.

The investment business is full of theories and recommendations about how to accumulate wealth. But the field has very little to say about the best ways to decumulate, or spend down wealth.

This is an astonishing oversight, considering that the period over which wealth decumulation occurs is often as long as that of accumulation. If the turning point between accumulation and decumulation is 65 years of age, then an investor needs to plan for a potential 30 years or more of decumulation — and that planning needs to begin before age 65.

In contrast, the period during which substantial assets are accumulated typically stretches over 30 or 35 years, starting around age 30 or 35.

The limited attention to formulating a theory of decumulation is all the more surprising, given that, with the retirement of baby-boomers, it is surely the foremost concern of more people than ever before. And it is a subject to which much more meaningful and scientific study can be applied than to wealth accumulation.

The best way to safely decumulate wealth

It is with that in mind that I will explain the surprising result of my own research.

Much of the research in this area has focused on the concept of “safe withdrawal rate.” It has produced some interesting, but limited, results.

A safe withdrawal rate is the percentage of your assets you can withdraw each year without danger of running out of money, no matter how long you live. The seminal work on the subject was written by financial planner William P. Bengen and published in the Journal of Financial Planning in October 1994.

Bengen asked the question, “What percentage of your starting assets can you withdraw yearly for the rest of your life without fear that you will run out?”

His answer, based on simulations using past history, was that you can withdraw 4% a year (adjusted for inflation).

For example, if you start with $500,000, you can withdraw 4% of that, or $20,000. If inflation in the first year is 5%, then the next year you can withdraw 5% more than that, or $21,000.

Bengen assumed a portfolio of 60% stocks and 40% bonds. Because an investor wouldn’t have run out of money given the past history of the stock and bond markets, even over a long life, Bengen declared this withdrawal strategy “safe.”

In Bengen’s words, “In no past case has it caused a portfolio to be exhausted before 33 years [after retirement], and in most cases it will lead to portfolio lives of 50 years or longer.”

But in recent years, stock and bond market conditions have changed. Interest rates are historically low. This has caused some researchers to argue that 4% is not a safe withdrawal rate anymore.

In 2013, three researchers found, using their revised stock and bond market parameters, that as low as a 3% withdrawal rate would still mean a 10% chance of running out of money — too big a chance for comfort.

Is this really the most that a retiree can spend with a high level of protection against running out of money?

The answer to this question unfortunately is, yes, the withdrawal rate from a stock-bond portfolio must be that low for an investor to be reasonably certain that she won’t run out of money (if you can call only 90% certainty “reasonably certain”).

The problem with safe withdrawal strategies from a stock-bond portfolio is that you have to keep a large percentage of your portfolio in storage as a buffer — a kind of “rainy day fund” (or to be more accurate, “rainy years fund”) — against market fluctuations, or a long life.

Chances are good you’ll leave a large portion of this fund behind you when you die. You won’t be able to spend it. If that’s not what you want — if your goal is only to spend as much as you can in your lifetime without running out — my calculations show that there’s a much better way.

Simple annuity

A simple annuity, also called a single premium immediate annuity or SPIA, is a financial instrument that guarantees you a consistent monthly income as long as you live. It should not be confused with the much more complicated, expensive, and much less useful annuities with other names, such as variable annuities or fixed-income annuities.

Many insurance companies offer SPIAs. For example, if you’re a 65-year-old male you can pay $100,000 to receive about $6,700 a year as long as you live.

Don’t confuse that 6.7% payout rate with the rate of return on investment. It is not, because the “principal” — the amount you paid at the beginning — is not returned to you at the end. However, if you care only about lifetime income, this doesn’t matter to you.

The level of safety of this income is confidently high — much higher than 90%. Although insurance companies do occasionally go out of business, insurance industry and government supports make the probability of a default on annuities very low. And unlike the safe withdrawal rate strategy, no “rainy years fund” has to be set aside, so you can spend the whole thing.

My own calculations show that for an investor to be 95% certain of not running out of money with a safe withdrawal strategy from a 60%/40% stock-bond portfolio, the strategy would be to withdraw 3.5% of the initial investment in real (inflation-adjusted) dollars each year.

If the portfolio started with $500,000, for example, the average annual lifetime income would be $23,000. With the SPIA, the average annual lifetime income would be $33,500, and the certainty of achieving it is greater than 95%.

Thus, both the certainty of not running out of money, and the lifetime income, are much greater with the SPIA than with the “safe withdrawal” strategy. This, of course, assumes that the investor has essentially zero interest in leaving a bequest. But this is the case for many baby boomers. Their children are independent, or they want them to be, or they have no children.

In these times of relative hardship for most middle-class retirees, the majority of baby boomers in the United States are more concerned that they will not have enough money to live out their years with a degree of relative comfort than they are with leaving a legacy. Given this objective only, it’s almost impossible to beat a simple annuity.

Because an annuity’s cash flows are rigid and constant, however, one would probably want to keep a small amount of money outside the annuity as “working capital” to even out fluctuations in expenditures. But it makes sense to put the bulk in a simple annuity.