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How Will I Know When I Have Enough To Retire?

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Saving for retirement.

My favorite topic….kinda.

As I’m mentioned previously, I’m not big on a traditional “retirement.” I love what I do and can’t comprehend leaving because I’m “too old.” However, I AM big on being able to tell “da man” to shove it whenever I feel like it. While I can’t imagine stopping work, I can completely visualize myself doing ONLY work I like whenever I like it.

Which brings up the question of the hour: How much should I save?

I’ve read countless pages on this topic written by well-meaning authors, and surprisingly, most get it wrong. Most discussions zero in on your risk tolerance and types of investments. These are absolutely ridiculous topics to tackle until you know the magic formula.

The Magic Formula

This is FAR easier than you might expect.

You only need three pieces to know how much to save before you start playing with investments and risk tolerance.

First, you need to know when you want to “retire” (or, in Joe lingo, tell the man to go f$%k himself).

Let’s talk about this number for a moment before we move on. Sure, you can make that number early, but what does that mean? as you make that number bigger and bigger you eat into today’s budget.

Also, realize that what you’re really trying to come up with is “how much money will I need if I don’t earn another dime between now and the time I die?” That means you’ll have to make a few assumptions about your goals

Second, you need to know how much money you can save.

Some people ask, “Why Not Just Save As Much As Possible?”

Really?

Do you want to do less today than you possibly could? Why would you sacrifice the now too much for a future that might never arrive? If you’re into pain, save every penny. Me? I’m more about balance. I want to save enough for tomorrow, but I also want my ice cream today.

Third, you need to know what return you expect on that money.

Financial guru Dave Ramsey famously had a public fight with Certified Financial Planners on twitter, who were admonishing him for suggesting that people can count on a twelve percent annual return on their long term investments. While I often love Dave’s advice, I never want to count on a return that’s higher than the average. Historically, most investors average far less than the financial markets, which have performed, over long periods of time, at around a ten percent clip.

We’ll tackle “risk tolerance” and when to think about that, later.

Those are it.

Once you have those three numbers you can arrange them like this:

Amount You’re Saving x Return on Investment = Your “Tell Off The Man” Goal.

Sure, you’ll need some calculators to figure out the formula, but I think you know where this is headed. Once you come up with the number you’ll need to “Tell Off The Man,” you can easily find out if your savings rate and return fit the goal.

Here’s When Risk Tolerance Matters

If you can’t meet your goal, you have a few choices to adjust course:

–    push back your “Tell Off The Man” date,

–    live on less after you tell him off,

–    save more money,

–    or jack up your rate of return.

Now your risk tolerance actually matters. Instead of choosing in a vaccuum, now you’re talking about risk toward meeting your goal. There’s a huge difference between “I really don’t like this type of investment” and “I’m not going to do what it takes to reach my goal, so something has to give.” As Steven Covey wrote in The 7 Habits of Highly Successful People, when you pick up one end of the stick, whether you want to or not, you pick up the other end, too.

Once you know the return you’ll need, it’s easy to look up which types of investments historically have given you that return. If you can’t stand the risk these investments present, you have three choices:

–    Teach yourself to take the risk.

–    Back down the risk and save more money.

–    Back down the risk and push back the goal.

See how that works?

Don’t get sucked into a “risk tolerance” quiz or investment discussion until you know your retirement formula. Why look up investments or make risk-based decisions without knowing what you have to do first?

Looking for more? Joe is cohost of the Stacking Benjamins podcast and writes at the blog by the same name. 

What You Need to Know About 529 Plans

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A 529 plan is a way to save for college expenses for a selected individual (usually a child or a grandchild. Depending on the state, there are specific tax benefits or advantages to having your money in this account versus a basic savings accounts.

There are two types of 529 plans, a 529 Savings Plan and a 529 Prepaid Plan.

Both savings plans have a list of allowable expenses that the plan money can cover. These expenses include:

  • Tuition
  • Books, supplies and equipment for classes
  • Fees (technology, etc)
  • Room and board (as long as the student is at least half time)

529 Savings Plan

  • The money is usually in mutual funds
  • As the beneficiary gets older, the owner may choose to be less risky with the mutual funds.
  • States run these plans.
  • Records are kept by mutual fund companies.

529 Prepaid Plans

  • The purchaser buys a credit at the current price, and that money invested will still be worth a credit when the beneficiary enters college.
  • States or colleges can offer prepaid plans.
  • Florida, Illinois, Maryland, Massachusetts, Michigan, Nevada, Texas, and Virginia are open to new enrollment in prepaid plans at this time.

Advantages of the 529 Programs

  • There are several states that offer tax deductions from 529 plans.
  • The principle is able to grow tax free.
  • The purchaser is the owner of the account, and may use/disperse the funds as they wish.
  • Fees are low
  • Easy to enroll, and automatic deductions are available

Disadvantages of 529 Programs

  • There are several 529 programs to choose from, not all are investments for higher education which creates some confusion.
  • Should you choose not to use the money for college, the money will be taxed at the current rate, plus an additional 10%.
  • A student may not qualify for as much financial aid if their tuition is payed directly from a 529 account.

Each state offers their own version of 529 plans, and some will transfer between the states. It is very important to check the laws in your state to determine eligibility and specific rules that will apply to you.

Using Options to Reduce the Risk of Fluctuating Stocks

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If you own or have followed stocks, you know that they can fluctuate wildly in price. There’s another game within the stock market known as options. This is a market all to itself which mimics the movement of stocks.

It’s not advisable for the inexperienced to play the option game itself, and this is why you’ll often see this disclaimer.

“Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital”

I’m only now learning about options but I do have 9 years of experience trading stocks. Before dabbling in that I learned the foundation, lingo and risks. It’s important to do the same with options. I routinely used the Motley fool stock advisor reviews for my research.

How Do Options Work?

The stock market is totally money driven. The stock you own has good news but the price doesn’t move – nobody cares, or better yet the price goes down – why? The money sold your stock on good news, confused? Welcome to the world of stocks.

Now, options are called “contracts.” Each contract has strictly defined terms. One contract equals the rights to control 100 shares of the stock that option is associated with. The key word is “controls” not own. Consider options like a lease with the option to buy.

Here is a perfect example from Investopedia

The idea behind an option is present in many everyday situations. Say, for example, that you discover a house that you’d love to purchase. Unfortunately, you won’t have the cash to buy it for another three months. You talk to the owner and negotiate a deal that gives you an option to buy the house in three months for a price of $200,000. The owner agrees, but for this option, you pay a price of $3,000.

Now, consider two theoretical situations that might arise:

  1. It’s discovered that the house is actually the true birthplace of Elvis! As a result, the market value of the house skyrockets to $1 million. Because the owner sold you the option, he is obligated to sell you the house for $200,000. In the end, you stand to make a profit of $797,000 ($1 million – $200,000 – $3,000).
  2. While touring the house, you discover not only that the walls are chock-full of asbestos, but also that the ghost of Henry VII haunts the master bedroom;      furthermore, a family of super-intelligent rats have built a fortress in the basement. Though you originally thought you had found the house of your dreams, you now consider it worthless. On the upside, because you bought an option, you are under no obligation to go through with the sale. Of course, you still lose the $3,000 price of the option.

Two Types of Options: Calls and Puts

  1. A call – The holder receives the right to buy an asset as a specific price within the specified time period. If you buy a call it is because you’re hoping the stock will increase before your option expires. A call is similar to holding a stock long term.
  2. A put – The holder receives the right to sell this asset at a specific price within the specified time period. If you buy a put it is because you’re hoping the stock will fall before your option expires.  A put is similar to holding a stock short term.

Buying Puts

You have 100 shares of IBM. The price is at $80.00 a share, you don’t want to sell the stock, but you have a feeling the next few months might be rough. In this case you can buy one put contract. A put contract protects a stock from going down.

How it works. IBM is at $80.00, you buy one put at a price of $75.00 for a term of four months. The price of that put is $5.00, that’s $5.00 x 100 shares (remember 1 contract equals 100 shares), so the price for this type of protection is $500.00. If within that four month time frame IBM goes down to $60.00 a share, you have covered the majority of the loss, $15.00 (the difference between your contract price of $75.00 and current price $60.00). If you were to exercise your option that day, you would make $1500.00 minus fees, and you still own the IBM stock.

What if you do nothing after four months? Remember, options are a lease against a real stocks. If you do nothing after four months your option expires, it’s dead. You paid $500.00 for insurance, for a specific time frame. If on the day your option expires IBM is still at $60.00, you reduced your loss significantly.

Here are two things to remember. You have the right to exercise your option at any time between the purchase date and expiration date. You can also sell your stock at any time and still own the options until expiration date.

This is the most basic of options for reducing risk against stocks.

Who Plays in the Options Market?

There are four types of players depending on the position they take:
  1. Buyers of calls
  2. Sellers of calls
  3. Buyers of puts
  4. Sellers of puts

If you buy an option you’re called a holder and if you sell an option you’re called a writer.

Key Differences between buyers (holders) and sellers (writers):

  • If you are a buyer of a call or a put you’re not obligated to buy or sell. You have the choice to exercise your option (contract) rights if you choose.
  • But if you’re a seller, call writer or put writer, you are obligated to buy or sell. This means that you (the seller) may be required to fulfill your promise to buy or sell.

It’s important to remember that being a seller is far riskier and involves a lot of rules you definitely want to know before venturing into this part of options.

The Lingo You Should Know

Strike Price – The price at which an underlying stock can be purchased or sold

In-the-money – For calls, if the share price is above the strike price. For puts, when the share price is below the strike price.

Premium – The total cost (the price) of an option

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5 Keys To Winning With Your Money

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Go Cheap? Yeah, probably not.

Hello, American Debt Project readers! I love what you’ve done with the place. If you don’t mind, I’m going to pop my suitcase in the guest bedroom. While I’ve been instructed by the puppet masters that I’m going to be writing here only once a month (your loss…), it’s still probably important that you know Joe’s rules to this game.

…and before I share them, I’ll mention this: I may not know everything about money, but 16 years in the trenches peeking behind the “money curtain” that hundreds of families hide from others leads me to strongly believe that this is the path to success:

Here Are The 5 Paths To Winning:

1)     The key to winning isn’t in avoiding lattes. I’ve met hundreds of successful investors and have had the privilege of peeking inside their budgets and portfolios. I hate to inform those of you cutting back on lattes that not a-one would credit avoiding Starbucks in the top ten reasons they’ve succeeded in life. In fact, many are avid latte-lovers.

That doesn’t mean that you shouldn’t watch dollars carefully. Clearly, wealthy individuals have a relationship with money that’s different than their non-wealthy counterparts. Wealthy people understand that money isn’t a permanently running faucet. They’ll save a buck on groceries because they won’t find value in spending more on a product.

2)     Whether you pay attention to nickels or not, wealthy individuals focus their time and energy on big problems and big solutions. Rather than cutting coupons to save $20 they create a side income or score more money from their job that nets them $200. Rather than worry about branded vs. unbranded cereal and saving $3, they refinance their mortgage when interest rates are low and save thousands. Even better, they stay away from high interest debt that steals hundreds of dollars from their pockets.

But hey, if you demand making a few bucks here and there off of unwanted stuff, give selling your old games or music a try with MusicMagPie.

I remember Crystal from Budgeting In The Fun Stuff telling me a story recently on our podcast about the name of her site. She said people were complaining on a well-known finance blog about a woman’s displays of wealth. They were ripping her for having a cleaning lady and for hiring someone to take care of some fairly easy tasks.

I’d be like that lady every chance I get. Here’s the deal: unless Shirley Maclean is right and we’re going to be reincarnated, we can only do this merry-go-round life one time, and I like the “merry” part of the go round. “Merry” doesn’t mean washing dishes or sweeping floors. Sure, I can find pleasure in simple tasks, but I’d much rather whine about my day in a hot tub over a foamy beverage than sweating while laying tile in the heat.

3)     That said, it’s easier to become wealthy if you cut out silly expenses. We realized a few months ago that we weren’t watching our Dish Network. I purchased a Roku  to see if we liked it. We did. We travel cross country fairly frequently, so a year ago I invested some money in a one year XM radio contract. Because I’ve found several apps for my phone and podcasts I like, we’ve cancelled that bill. These are silly expenses that we no longer need.  Together they save us nearly $100 per month. That’s money I can spend on a housekeeper, if I choose.

4)     Winning usually means surrounding yourself with great advisors. Sure, I believe in saving money whenever possible, but in unimportant areas. I haven’t met wealthy individuals that didn’t have some prominent advisors helping them. When you ask successful people how they became successful they discuss breaks, mentors and hard work. You have to sometimes hire great coaches to reach the highest heights.

I read “Don’t hire advisors” pieces on the internet and groan. The authors of those articles are missing the point. You should hire the RIGHT advisors, not ditch all advisors. Can’t afford an advisor? Start a mastermind group with people who are headed in the same direction. While you might miss out on the shortest route to solving your problems, you’ll be able to look at issues from multiple points of view and find success more quickly.

5)     You need a basic understanding of investing so that you don’t get robbed. I’ve never met a wealthy individual who said, “I don’t know much about investments.” Sure, you may be afraid of the jargon and semantics of investing, but that’s a hill you must climb if you’re gonna be successful. I’ll put it bluntly: in the financial advising business we could see noobs from a mile away, and there were some pretty predatory individuals working in that industry. It’s okay if you don’t understand the complexity of investments….and don’t let that stop you from hiring good advisors if you feel you need them…..but you need (NEED!) a basic understanding of how this works. Read beginner books on the topic. Suze Orman and Dave Ramsey keep it interesting. Keep reading this blog. Fill your mind with the topic.

Hopefully those help you start down this path to financial success more quickly than you would without this roadmap. Financial success isn’t only profitable: it’s also fun. Once you watch your net worth begin to ascend, you’ll feel like a mountain climber reaching for the next wrung. Instead of prodding yourself to try and cut your budget you’ll be dancing toward your next financial milestone.

…and that’s a fantastic feeling.

Joe Saul-Sehy is the co-host of the popular podcast Stacking Benjamins and also writes at the blog sharing that same name.

Do You Really Need An Emergency Fund?

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Here’s some advice you hear over and over….build up your emergency fund first, even before paying off debt.

Are you kidding me?

Let’s do the math: if you’re paying 21% interest on a debt and it takes two months for you to build up Dave Ramsey’s $1,000 as the first step to your cash reserve, you’re letting a ton of interest accumulate on your debt. Additionally, that money you’re saving? It’s netting you somewhere in the range of .01%…if you’re in an interest bearing account at all.

Additionally, why put this money away in the first place? If you’re paying 18% on a credit card, why the hell aren’t you paying every dime toward getting rid of that debt? Something bad happens, what do you do? You just put the money back on the credit card.

It’s just plain math.

So why do people recommend an emergency fund?

Because life isn’t about math.

Did I have you on the “screw the emergency fund” train? Well…that was my goal, but I was messing with you. While I can appreciate the math above, I think there are many factors at work that make me, among many others, recommend building your emergency fund rather than investing the money.

As someone who’s counseled hundreds of people toward financial success, I can say unequivocally that you need an emergency fund.

–       I don’t care what the interest rate on your debt might be. You need an emergency fund.

–       I could care less how “nothing is going to come up.” You must build an emergency fund.

–       It’s irrelevant how much cash flow you have or how great your credit might be. Go build your emergency fund. Now. Before doing anything else.

Emergency funds aren’t about math.

To help you understand just how incredibly misguided people are who advocate NOT building an emergency fund, let’s take you through another example. This one isn’t about math. It’s an example about human nature, real-life situations, and utility:

Jim-Bob has $20,000 in credit card debt. He’s been trying to pay it off for the last five years, but whenever he gets close to having it paid, something happens. His muffler is dragging behind the car. His dishwasher breaks down. Life happens.

Sound familiar?

Here’s the magic behind building your cash reserve first:

1)   You can pay every dollar toward your debt, but then you have to make sure nothing happens while you’re paying off the card. How many times have you NEVER had anything happen to you during a three or four month period? Ha! Of course stuff happens! Life hits you from out of the blue! Woody Allen is right: “Life is what happens when you’re busy making plans.”

2)   If life DOES happen and you take out your credit card, what are you really doing? You’re teaching your subconscious mind that it’s okay to use this debt in an emergency.

I’d submit that this is the biggest part of the problem. We think that “It’ll be okay just this one time.” It isn’t okay. A credit card isn’t your money. You’re using someone else’s money to solve your problems. 

I believe that the first step toward independence is to make yourself independent. Right. F-ing. Now.

Stop borrowing from the credit card company. If real life jumps up and grabs you, teach yourself to stop turning toward the credit card. You’re better than that.

3)   Finally, your emergency fund helps you build another muscle: the “saving is the most important part of the equation” muscle. People often pay off debt and then find themselves like a boat in the ocean without wind. They have nowhere to go.  That’s why the next point is critically important:

Paying off debt isn’t a goal. It’s a hurdle.

When I first switched from financial planning to blogging, I let people fight me on this point. One of the same bloggers who fought me (because his blog was all about how he was paying down his debt) struggled immensely after he paid down his debt. Don’t listen to people who haven’t been there before: you need to see debt as a hurdle, not a goal. If you have nothing on your mind beyond paying down your debt, you won’t succeed. Period.

I totally get that achieving debt zero is an important milestone for people. But when you make it a goal and spend every dollar toward paying debt without thinking critically about real life, you’ll make the mistake of avoiding an emergency fund and instead then wallowing in debt long term. I don’t agree with Dave Ramsey on every point, but on this one I’ve seen eough success to tell you point blank:

Build your emergency fund right now.

Disagree? Let’s hug it out in the comments below.

Joe Saul-Sehy is the co-host of the Stacking Benjamins podcast and writes at The Free Financial Advisor – Average Joe’s Money Blog.