Your Retirement Questions Answered

When people find out I write a financial independence/early retirement blog, they sometimes take a breath and start peppering me with questions.  I thought it may be helpful to y’all if I answer the questions I get asked most often.

How much should I contribute to my retirement?

If you want to retire at a typical age then 15% of your gross salary before taxes and benefits.  This 15% can include your company match.

At my last job, the company matched 25% of my contributions up to 6% of my salary so that worked out to a 1.5% total match.  If I wanted to retire around my full retirement age for Social Security, then I should have contributed 13.5% of my money.

If you want to retire early, you should be contributing 15% to your retirement and saving outside of your retirement accounts as well.  How much depends on your expenses and risk profile.  Run a few calculators, or build a spreadsheet and figure it out.  Here’s a calculator from Vanguard.

What if I started late or don’t have much saved now?

You’ll probably need to max out your company retirement plan–currently $18,000 if you are under 50 or $24,000 if you are 50 or over.  Plus max out an IRA–currently $5,500 if you are under 50 and $6,500 if you are 50 or older.

Use a retirement calculator to figure out what you need.  Here’s the Vanguard calculator again.  Depending upon your risk tolerance, their default return of 5% may be too high after inflation.  Enter your information and then adjust that return.

But I can’t afford to contribute 15%.

Commit to increasing your contributions by at least 1/2 of any future salary increases.  You may be able to automate this with your Human Resources Department.  Throw all bonuses and extra income at your retirement too.  This is the easy way to fund your dreams.

Look for ways to reduce your spending.  Sorry but this is that important.  Need some ideas?  Check out my spending less articles.

Which retirement account should I use?

Use your company 401k, 403b etc. up to the company match.

Then fund your IRA up to the max.  You MUST automate this–set up a monthly transfer from the account your paycheck goes in.

Then back to your 401k, 403b etc. until your reach 15% of your gross salary in total.

Why not put all of my retirement savings in my company’s retirement plan?

It costs a lot to administer a retirement plan so typically you pay fees on top of the expense ratios in your underlying funds.  My old company’s plan was a good one with low fees but I still paid about .5% a year of these fees on top of my fund expense ratios.  It may not seem like a lot, but over decades fees matter.

If you don’t automate your contribution to your IRA, it will never get funded.  So until you get around to automating this transfer, use your company’s retirement plan for the entire 15%.

I find all of this very confusing.  Mutual funds, mutual fund companies, 401k plans, etc.

I think Jean Chatzky explains this best (her podcast, Her Money, is one of my favorites BTW).  Think of it like a cup of coffee.  The type of account–non-retirement, 401k, 403b, or IRA is the cup, it holds your investment.  The coffee is the actual investment–mutual funds, stocks, bonds etc.

I’ll add that the fund company is where you buy your coffee or the investment–Vanguard, Fidelity, Charles Schwab etc.

What is a Roth IRA or Roth 401k?

The Roth retirement accounts are named after the Senator who proposed this form of retirement account.

With a traditional IRA, 401k, 403b etc., your contributions are deductible so they reduce your taxes.  When you withdraw the money, you pay taxes on all of the withdrawals–your contributions and any earnings on those contributions.

With a Roth IRA, 401k, 403b etc., the contributions are not deductible when you make contributions.  So you pay taxes on the contributions.  BUT, when you withdraw the money, you won’t have to pay taxes the withdrawal–both your contributions and any earnings on those contributions.

Should I contribute to a Roth IRA or Roth 401k?

Maybe . . .

There are some huge advantages to a Roth.

First, the withdrawals are more flexible than a traditional retirement account.  You can more easily access the money you contributed before age 59 1/2.  And there are no required minimum distributions from a Roth account so the money can grow longer.

Second, it allows you to lock in today’s tax rates rather than have the risk that rates will be higher when you withdraw the money.  We’ll need to fund our country’s huge deficit at some point, right?  It seems like that will require income tax rates to go up but they won’t go up on your Roth accounts–those taxes were already paid.

But . . .

If you are in a high tax bracket now, while you are working, it may make sense to take the deduction now.  You’ll likely be in a lower tax bracket when you are retired.

And, because you have to pay taxes on your contributions to the Roth account, you may have less money available to contribute.

The math . . .

Let’s say you pay 25% Federal and state tax on your incremental income.  You contribute $5,500 to a traditional IRA or $4,125 ($5,500 less 25% tax) to a Roth IRA.  You invest the money in the same investments and pay the same fees.  When you withdraw the money, you pay 25% tax on the traditional withdrawals and no tax on the Roth withdrawals.  You are left with the exact same amount.

But, if you can contribute the full limit of $5,500 to the Roth account, you’ll have more money with the Roth.

Did you contribute to a Roth account?

I have only about 3% of my spendable investments in a Roth account.  For most of my career, my employer did not offer a Roth 401k and our income was too high to qualify for a Roth IRA.

I probably should not have used Roth.  Our tax rate was high so the deductible traditional contributions would have been more valuable to us.  I wanted the flexibility of getting at this money before 59 1/2 but ended up with enough money outside of my retirement accounts that I shouldn’t need to access the Roth.

If you’re not sure what to do, a good solution is to put half in Roth and 1/2 in traditional.

Should I take a 401k loan?

NO.  This should be your loan of last resort as it puts your retirement at risk.

You’re typically paying interest back to the account at a much lower rate than your investments would have earned.  It may not seem like you’re losing much here, but compounded, over a 30 year career this difference can be significant.

If you quit, are laid off or fired, the loan must be paid back within 60 days.  If it is not paid back, it becomes an unqualified distribution which is subject to a 10% penalty unless you are at least 59 1/2.  Plus you have to pay taxes on the distribution.  POOF – about 40% disappears.

Where should I have my IRA account?

I like Vanguard–their account holders (us!) own the company so they are not answering to two masters–shareholders who want them to make money and account holders who want low fees.

Fidelity and Charles Schwab are good too.

Whichever company you select, pay attention to the expense ratio on the funds you select within the account because Fees matter.

I left my company, what should I do with my old 401k?

Move it to Vanguard.  Or Fidelity or Charles Schwab.  This will eliminate the fees your 401k provider charges you.

Super important:  before you do anything, contact the fund company you are going to transfer the money to.  They will facilitate the transfer from your employer’s plan so the transfer is not considered a distribution.

If you take the money yourself, the IRS considers it a distribution, you are taxed on it and cannot put it back in an IRA.

What funds should I invest in?

This one’s tricky and depends on your tolerance for risk.  Fill out a questionnaire to figure out your risk tolerance.  I like this one from Vanguard.

The worst thing you can do is invest and then pull out your investment when it goes down.  And someday the funds are going to go down!  You have to make your investment decision and then leave it there.

I love JL Collins’ stock series  read Part VI: Portfolio ideas to build and keep your wealth. or buy his book*.  Then make the decision that is right for you.

What about the life cycle funds offered by Vanguard or my company’s retirement account?

Many fund companies offer a fund of funds called something like life cycle #### or retirement #### where the desired retirement year is included in the fund name.

These are definitely the easy button.  They invest more aggressively (in stocks) when the retirement date is far in the future and gradually shift more towards bonds as the retirement date draws near.

Make sure the expense ratios on the funds are low.  Vanguard’s average LifeStrategy Fund fee is .14% so you pay $1.40 a year on $1,000 balance.

If you don’t want to think about this stuff, the life cycle funds are your easy button.

What funds do you invest in?

Largely Vanguard Total Stock Market Index Fund–VTSAX, I wrote about the details here.

I have a chunk of money sitting in my checking account, how do I get it invested?

First of all, your primary checking account is the absolute worst place to have a large chunk of money.  It is your account that is most likely to be hacked.  Move extra money to a savings or high interest checking account that is not connected to your primary checking account right away.  Check out Bankrate or MagnifyMoney* to find a high interest savings account.

OK, now that we have your money out of your checking account, JL Collins would tell you to just open a Vanguard brokerage account and buy VTSAX because the market always goes up.

But I’d have a hard time doing that–if the market goes down (which it will eventually), it would be really hard to see my money evaporate even if it is only temporary.

I’d pick a time period over which I want to invest it–say if I had $100,000, I’d set up an automatic transfer of $5,500 each month into a stock fund.  This would get all of the money invested over 18 months.

This method of setting a dollar amount to transfer is called dollar cost averaging.  Because you’re buying a fixed dollar amount each month (or week or quarter etc.), this method results in you buying fewer shares when the market is high and more shares when the market is low.  Your average share cost ends up being lower (better) than if you just bought a designated number of shares each month.

OK, what did I miss? 

* I’ll receive a small commission if you order Jim’s book through the provided link.  The Stacking Benjamins Podcast receives a commission if you use their magnify money link.  I love their podcast and magnify money is a great resource so I thought I’d help them out.  No other links provide commissions.

Social Security Is My Bond Portfolio

My Dad is an Investor.  I say Investor with a capital I because I remember him studying investments in his home office (aka my brother’s former bedroom) for hours when I was a teenager.

He’s the first early retiree I knew.  So when he shared a bit of his investment philosophy with me, I listened.

In spite of being in his late 60’s at the time and retired with no significant pension, he continued to be invested very aggressively and held very little of his investments in bonds.

He said Social Security was his bond portfolio.

This approach worked well for him.  He’s now in his late 70’s and running out of money is not even possible (he was also the first frugal person I knew!).  Though he recognizes he would have been better off investing in index funds and saving the hours he pored over investment reports.

I’ve followed in his footsteps on many things and I’m following him on this one too. Continue reading “Social Security Is My Bond Portfolio”

My Visit With Warren Buffett

The typical investor has no business investing in individual stocks.  Most of my investments are in Vanguard index funds–VTSAX is my favorite.  Until recently, I owned only two individual stocks.  I also own some managed funds (which carry higher fees) but I would move all of my investments to VTSAX if I could do it without paying taxes on my gains.  You can learn more about my investment philosophy here.

A few months ago I broke one of my cardinal rules. I bought another individual stock–BRK–Berkshire Hathaway.  I bought it only because I wanted to go to the annual meeting and see Warren Buffett (world’s 2nd richest person) and his partner, Charlie Munger talk about investing and life.  A trip to Omaha doesn’t sound all that exciting but this annual meeting is a real spectacle–more about that later. Continue reading “My Visit With Warren Buffett”

Fees Matter . . . A Lot

Do you know how much you are paying in mutual fund fees?  You should, because fees matter . . . a lot.

When you hear people talking about mutual fund fees, they are usually talking about the expense ratio.  This is the percentage charged against the earnings of your fund each year.  These fees pay the operating costs of running the fund and, usually, return a bit of profit to the company running the fund.

My focus in this article is going to be on this expense ratio. Continue reading “Fees Matter . . . A Lot”

You Should Leave A Job With More Than Just Memories

When I retired, I rolled my 401k balances over to IRA accounts with Vanguard.

My company’s 401k plan was a good one.  They even offered my favorite Vanguard fund (VTSAX). But all 401k plans have fees in addition to the underlying fees of the funds where the money is actually invested.  This is because of the reporting requirements, paperwork and account holder support that 401k funds provide.  Those services cost money so each quarter I’d see some of my money disappearing to pay those fees.

With Vanguard, I pay the underlying fees of the funds and nothing else.

Converting my account was easy.  They even assigned an account rep. who monitored the transition and kept me updated on its progress.

I think the account rep. thought I was crazy. Continue reading “You Should Leave A Job With More Than Just Memories”

The Stock Market Seems Really High . . . Should I Sell?

Election night it looked like the stock market was going to tank.  S&P 500 futures were down about 15%.  I was scared for my country and my money.  I was preparing to write an article celebrating that stocks were on sale and telling everyone to stay the course or to buy.  Rather than crashing, we saw the S&P 500 go up over 1% the day after the election and it has only continued to rise since then.  This is a very different article but the answer remains the same.

This post-election stock run up has been amazing.  Through Christmas weekend, we hit all time highs.  My invested assets grew over 3% in November and an additional 2% so far in December–the annualized return is over 30%.   I made more these months than I’m likely to spend in all of 2017.

Price to earnings ratios are very high.  This ratio compares how much a stock costs to the earnings companies reported over the previous 12 months.  We’re paying almost $26 for $1 of earnings for S&P 500 index funds.  The historic average is under $16.

So the market looks expensive.  Does that mean this would be a good time to sell and wait for a dip in the market to buy back in? Continue reading “The Stock Market Seems Really High . . . Should I Sell?”

For Investing, You Must Know Yourself

Over a quarter of my net worth is from investment growth and at least 15% is from real estate growth.  So 40% of the wealth that allowed me to retire didn’t come from working and saving, it just came from taking some risk and letting my money work for me.

I already admitted I’m not an investing genius and I was my own worst enemy when I thought I was.

The most important thing with investing is to know yourself.  What level of risk are you comfortable with?  When will you need this money?  How will you behave in a market downturn?  There are lots of risk tolerance tools out there, this one from Vanguard is a good one.  When you complete this questionnaire, be sure to think about how you will behave, not how you should behave.

Continue reading “For Investing, You Must Know Yourself”

The Early Years Are the Hardest

After I posted my recent savings rate, I began to wonder how that savings rate changed as I got older.  In the early years, I was earning less and was paying rent or mortgage payments.  Both my earnings and my expenses improved as I got older.

So I went into the way back machine (my Excel budget spreadsheet) and calculated my savings rate each year. Then I thought it might be helpful to know my net worth each year as a percentage of the net worth I had when I retired this spring.

savings-rate-nw-accum2

Continue reading “The Early Years Are the Hardest”

Money and Marriage

Boy, this can be a tough one.

I came into marriage with some baggage from my childhood and a vision for what it meant to be a professional woman.  Both of these put me in opposition to the ways couples traditionally treat money in their marriage.

First, the baggage.  My parents fought about money . . . a lot.  It was a constant undercurrent in their marriage.  My Dad was what we’d call frugal today.  My Mom was more towards the middle on the frugal-spendy spectrum.

Continue reading “Money and Marriage”