Counter-Intuitive Plan for Retirement

[tomcat]

...an interesting read for those whose retirement goes beyond a bottle of vodka and a shotgun:

The case for saving less for retirement
by Ben Steverman (Bloomberg)

In 2016, I finally paid off my student debt. Practically every other cent left over after rent and other living expenses went into my retirement account. Was it a mistake to load up my 401(k)? Thomas Anderson thinks so. This is our story.

Compared with the average American, I’m doing all right. I have a good job, I’m saving regularly, and I’m debt-free for the first time since graduate school. That doesn’t feel like nearly enough, though, not in Manhattan anyway, where everybody else seems to be enjoying $200 monthly gym memberships, $500 Broadway tickets, and $800 parkas.

Those of us not born into money, or likely to stumble into it, are stuck building wealth the old-fashioned way, over decades of hard work, good luck, and hundreds of smart choices about our careers, our investments, and even our romantic lives. There are plenty of rules to help guide you in making these choices. The one I’ve been sticking with is pay down debt as quickly as possible while saving as much as possible for retirement.

Turns out that rule is wrong—at least according to The Value of Debt in Building Wealth, a new book by Anderson. A former Morgan Stanley financial adviser, he now heads Supernova Cos., a firm that sells educational materials and tools to advisers. With an MBA from the University of Chicago, the 42-year-old is also the kind of guy who names his dog after a Nobel Prize-winning economist (Harry, for Harry Markowitz) and harbors a healthy obsession with mathematical concepts such as the Fibonacci sequence. “In our anti-debt world, most people are taking on too much debt too early in life and paying down that debt too aggressively,” he writes. “As a result, they are not saving until later in life,” when they have lost much of the power of compounding.

So maybe I shouldn’t have paid off my student debt last year after all? Luckily, I could ring up Anderson in Chicago and ask him. I know him from writing about one of his previous books, which argued that individuals, especially the wealthy, should be more sophisticated in wielding debt as a financial tool.

Anderson doesn’t seem to think zeroing out the student loans I’d been dragging behind me for 14 years was such a bad idea, especially compared with other far more serious mistakes I’m making—namely, locking up way too much money in my retirement accounts and investing too heavily in stocks.

The Value of Debt contains several nuggets of pithy advice: Aim to save at least 15 percent of your income. Also, “the best way to feel rich is to live in a less expensive home than you can afford.” Yet Anderson mostly steers clear of one-size-fits-all prescriptions. Instead, he divides readers into four financial profiles, from those just starting out all the way to the very rich. The key criterion isn’t how much money you have. What matters—and what determines your progress from one end of the wealth spectrum to the other—is how you balance the various components of your financial life: income, savings, and debt.

It’s all about getting the proportions right. If your net worth is less than half your annual income, for example, you should “avoid taking on any new debt” at all. If you’re in Anderson’s second phase, more or less where I land, you should aim for: no “oppressive” debt; a cash reserve six times your monthly gross income; retirement savings six times your monthly income; and last but not least, you should have a separate pot, for “big life changes,” like marriage or buying a home, equal to nine times your monthly income.

Filling out the book’s worksheets, I was surprised to learn I’m woefully short of cash, with less than half of the money recommended. Most surprising was seeing that I had in my 401(k) and individual retirement accounts three times what Anderson recommends.

“I need Ben to have more flexibility,” he says, referring to me. That means more cash and more after-tax investments that I can sell during an emergency. What if I lose my job during an economic downturn? “You’re not going to want to take just the first job that comes up,” Anderson says. “You’re going to need to ride it out” for three months, six months, or even longer.

Liquidity, the ability to access your money when you absolutely need it, is a key concept for Anderson. A thousand dollars in the bank is more useful than $1,000 tied up in a retirement account that charges a penalty for withdrawals—or in collectible figurines.

It isn’t just about riding out a crisis. Liquidity is also important for smart investing and homeownership decisions. I tell Anderson that I, unlike my younger siblings, don’t own my home. And I have 100 percent of my investments in stocks. While criticizing my investing philosophy, calling it “dangerous,” he endorses my decision to rent, for now. His reasons for each are similar. Stocks and real estate are at record prices. At some point, those markets will crash. “Then you have the flexibility and liquidity to step in and buy,” he says.

I’ve started to take Anderson’s advice. I moved some of my investments out of stocks just as, luckily, equities were hitting new highs. I haven’t gotten around to lowering my 401(k) contribution yet. Would the extra money in my paycheck simply inspire me to spend more? Maybe. I really should buy a warmer coat, donate more to charity, and finally see Hamilton.

The bottom line: A new book cautions against paying down debt too aggressively, telling readers to build up their rainy day savings instead.

[Lancelot]

Interesting.

Debt for appreciables can be profitable. There is a tiny house movement in the USA; people finally have figured out that they really don't need a 5,000 sq foot McMansion

Another shift in US consumer consumption is that people are buying less apparel at brick and mortar stores. Malls are losing traditional anchor stores and there goes the mall.

We live in interesting times. IMHO, a Total Stock Market Index fund, with five basis points of expense is the way to build wealth

[tomcat]

IMHO, a Total Stock Market Index fund, with five basis points of expense is the way to build wealth

...one way, certainly...though more varied allocation of assets would reduce risk...

[Lancelot]

IMHO, a Total Stock Market Index fund, with five basis points of expense is the way to build wealth

...one way, certainly...though more varied allocation of assets would reduce risk...

Asset allocation is an orthodoxy on some investment boards

Same, same with safe withdrawal rate

[Lancelot]

The younger an investor is, the more I would argue for putting most of your portfolio in an Index Fund. ANd stay invested during market crashes; that's where the money is made.

But yeah, older investors need to pay more attention to allocation, so they don't have to sell shares at reduced prices...

[tomcat]

Asset allocation is an orthodoxy on some investment boards

...call me orthodox...

[Lancelot]

No worries buddy, go for it

[Cold Pizza]

Thanks for the article, TC.

[lob]

dont take on debt,,,, unless it makes money in the long term .... u cant afford it dont buy it.... dont spend more than u earn. all common sense. once u get on top of it all , the money just rolls in..

[redhaze]

Liquidity, the ability to access your money when you absolutely need it, is a key concept for Anderson. A thousand dollars in the bank is more useful than $1,000 tied up in a retirement account that charges a penalty for withdrawals—or in collectible figurines.

I'm a big believer in this idea of liquidity. Each of us, if we are lucky, has the opportunity to make maybe 3 or 4 big financial moves our entire lives. Better have the money to make it count, because those moments don't come along every day.

[fishlocker]

A penny saved is a penny earned.

Who would have guessed ten years ago Sears would be on the verge of bankruptcy today.
I picked up Kohls Corp at the IPO for 14 a share. They were going nation wide. The stock split four times and got as high as 80ish. Now its about 37. Hindsight is allways 20/20 or as my father would say 60/40. Having said that I see nothing wrong with holding stock as it is relatively liquid. As for a retirement account I say invest early and often in funds that don't eat your gains with their fees.

As for stocks I like a solid dividend payer but also growth stocks. As for real estate everyone has to live somewhere. I allways figured it's better to own your own home, why make the landlord rich.

[CaptainNemo]

dont take on debt,,,, unless it makes money in the long term .... u cant afford it dont buy it.... dont spend more than u earn. all common sense. once u get on top of it all , the money just rolls in..

Most people need to take on debt to get anywahere... debt for education and training; debt for a house; debt for a car... these are the norms that get people up and out of their bedrooms at 18 and set up for prosperity. Though I'm not entirely sure about whether apprenticeships are better than higher ed, some companies are starting to do hybrids, which is obviously desirable to help a nipper get started without crippling lifelong debt (even if UK student loans are probably the cheapest debt on the planet).

[tomcat]

I'm a big believer in this idea of liquidity

so am I: 6-9 months of salary in a savings account or CD as an emergency fund...any other cash can be diverted to less liquid, but still readily available (say3-5 business days) mutual funds or the like...except for my pension, I'm cashed out of stocks and bonds, but still keep that emergency fund in a US bank in case SD and I have to hoof it when the swamp implodes...

[SKkin]

when the swamp implodes...

we're draining that...

[CaptainNemo]

This guy doesn't seem to agree... (a British perspective, rather than an American one)

Clear debts or save? Max your cash - MoneySavingExpert

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Martin
Updated January 2017

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Those with debts AND savings are seriously overspending but the solution is simple. Pay the debts off before you save and maybe even your mortgage. Forget the old ‘must have an emergency savings fund' logic as getting rid of debts beats that too.
This guide explains how to pay off debts rather than save and the logic behind it.
In this guide

• Yes, pay off debts with savings
• Banks love us to save and have debts
• Exceptions to the rule

• Dealing with emergencies
• Should you pay off mortgage with savings?
• Pay off the most expensive debts first

Considering paying your student debt? Read Should I Pay Off My Student Loan? guide for more.

Yes, pay off debts with savings...

I can almost hear the dismay at this suggestion, “What? All we hear about is Britons don't save enough and, here I am, trying to do it and you say don't! What are you talking about man?” So let me explain the basic reasoning straight away...
It's that simple. Debts usually cost more than savings earn. Cancel them out and you're better off.
What about tax?

Savings interest can also be hit by tax too. Though this is much less of an issue than it used to be, as since 6 April 2016, the new personal savings allowance means most people don’t pay tax on savings. Though if you earn a lot of interest you may do. If so, factor that in, it makes paying off your debts even more attractive.

Banks love us to save and have debts

Put most simply, when you save money you're actually lending your cash to the bank for it to lend on to other people. The difference between the rate at which it borrows money from you (the savings rate) and the rate it charges others (the borrowing rate) is its profit. Therefore, on the whole, it'll always cost more to borrow than you can earn by saving.
This is why I find it deeply frustrating that many people have both borrowings and savings at the same time, often with the same bank. Effectively it is lending you back the money you lent it, except charging you much more. Ridiculous!
Think about this, it's actually quite shocking. I once made a speech to the Building Society Association conference, which was puffing out its chest at how much better than banks they were.
So I asked how many of their savings managers' salaries were based on the value of savings they brought in. Many were. Then I questioned how many got the branch staff to ask people opening savings accounts if they had debts. Not one!
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The exceptions to the rule

The rule is based on the fact that the cost of debt is usually much higher than the benefit gained from savings. Therefore your pocket gains more by getting rid of the debt than starting to save.
The exceptions are in the few occasions when debts are cheaper than savings, or cost so much to pay off that there's no point:

• The penalty exception. If you're locked into the debt, so that paying it off incurs a penalty, as with some loans or mortgages, then leave the cash sitting in a savings account until the penalty's small enough that it doesn't matter.
  More details on loan lock-ins are in the Cut the Cost of Existing Loans guide.
• The interest-free / very cheap debt exception. Debts cost. Yet those who carefully and conscientiously manage their debts so they're constantly interest-free should follow the opposite logic.
  If the interest rate on your debt is less than the amount your savings earn after tax then, providing you're financially disciplined, you can profit from building up savings and keep the debts. In effect, you're being paid on money lent to you by the banks for nothing.
  There are a number of products where this is possible: introductory 0% credit card offers (see Best Balance Transfers and Purchases Cards), 0% overdrafts (see Best Bank Accounts, Student Account and Graduate Account articles) and Student Loans (see Should I Pay Off My Student Loan?).

Should you have an emergency fund?

Emotionally, many will find what I'm about to say difficult to deal with. The idea of having some cash in a savings pot feels safe, especially as traditional budgeting logic berates us to always have an ‘emergency cash fund'.
I disagree. It's a must-do aim for the debt-free, but for anyone with expensive debts – particularly on credit cards – it's silly.
The right thing to do is still pay off your debts with savings, including your emergency fund. Yet don't cut up your credit cards, it's important to keep the credit available in case of a substantial emergency (and substantial means just that, your roof falls in or you can't feed the kids; not a new plasma TV).
A practical example: Johnny Comelately

Johnny Comelately currently has £5,000 saved up, earning 1.5% interest, in case of emergency, yet he also has £5,000 on credit cards at 18%. Thus while his savings are earning him £75 a year, his debts cost £900. Overall he is paying out £825 a year.
Now compare what happens if he pays off his debts with his savings, with not doing so:
Situation A: No emergency happens

No change. Keeping both debts and savings costs Johnny £825 a year.
Pay off debts with savings. Johnny now neither earns nor pays any interest, thus is relatively £825 a year better off, and all the new cash he puts aside can go towards genuinely saving.
Situation B: After a year he has to pay £5,000 for an emergency roof fix

No change. Johnny uses the savings for the emergency. This leaves him with no savings and £5,000 of credit card debt at 18%.
Pay off debts with savings. As Johnny has no savings, he has to borrow the £5,000 on his credit cards. This leaves him with no savings and £5,000 debt on his credit card at 18%.
In other words, Johnny is in exactly the same position in situation B, regardless of what he does. Yet before the emergency he was £825 a year better off by paying off his debts with his savings.

So overall, whether an emergency happens or not, the best result is to pay off your debts with your savings. The only time to beware of this is if you're not assured of being able to reborrow the cash.
Usually with credit cards it's fine, as they're a readily available source of credit, but if your debt is a personal loan, there's no guarantee you will be able to get another – in which case an emergency fund is sensible.
The disciplined exception

Those making a concerted effort to repay serious debts may find the idea of reusing credit cards a real danger. Yet while it isn't a sensible strategy to have an emergency fund, as there's no guarantee you'll ever need it, there is some justification for making small savings provisions for specific future events.
For example, saving a small amount each month towards Christmas, (see budgeting article) for those who can't trust themselves to stick to the limit on credit cards, is a sensible personal financial strategy. Yet keep it to limited amounts of cash.

Should you pay off your mortgage with savings?

Many people don't think of their mortgage as a debt, yet of course it is. However the key difference is mortgages are usually at a much cheaper rate and less flexible.
In this case the difference between debt and savings is much smaller, but you're still better off using the savings to clear your mortgage debt. And remember the above assumes you're with the Top Savings Account, which sadly most people aren't.
Yet there are a number of exceptions and hurdles to this, for full details, including a specially designed calculator, read the Should I Pay Off My Mortgage? guide.

Pay off the most expensive debts first

Sadly, many people have much more debt than savings. So even if you use all your cash to pay them off, you'll still have debts left. Therefore, it's important you prioritise using your savings to get rid of the most expensive debts.
Before you do this, check to see if you can lower any of your debts' interest rates.

• For credit and store cards, read Best Balance Transfers.
• If you get rejected for new credit then you can still cut rates using The Credit Card Shuffle.
• If you have a loan read Cut the Cost of Existing Loans.
• For cutting costs on your mortgage read the Remortgage Guide.

Once your debts are as cheap as they can be, list where they are and the amount of debt that you have. Then use your savings (or spare cash) to pay off the most costly debts first. All this done together should massively reduce your costs.

[UrbanMan]

whose retirement goes beyond a bottle of vodka and a shotgun

So, not those high school educated whiteys described on the other thread.

Stocks and real estate are at record prices. At some point, those markets will crash.

Rising interest rates might be the catalyst. Stand by.

I haven’t gotten around to lowering my 401(k) contribution yet. Would the extra money in my paycheck simply inspire me to spend more? Maybe.

The downside of having easily accessible cash - requires discipline many do not have. If the book is thorough, it addresses this.

[CaptainNemo]

Stocks and real estate are at record prices. At some point, those markets will crash.

Rising interest rates might be the catalyst. Stand by.

People keep saying that... guess how long this website has been saying that for?
House price news, information and discussion - HousePriceCrash.co.uk

[redhaze]

The downside of having easily accessible cash - requires discipline many do not have.

AKA people who will work forever.

[tomcat]

AKA people who will work forever.

...another possible AKA: people who have to work forever...I imagine that being in one's 60s and still needing the income from a job to survive is anxiety-inducing...a lack of foresight? A lack of financial discipline? Bad luck?...or just stupid?

[redhaze]

People keep saying that... guess how long this website has been saying that for?
House price news, information and discussion - HousePriceCrash.co.uk

All that chart proves is that housing rises over a long enough time frame. Take a chart of the prices of ground beef or basically anything else and you get the same curve. It doesn't mean there aren't terrible times to buy a house.

Where you you rather buy on that chart, 1995 or 2005? Because the guy who purchased in 1995 and sold around 2005 got rich, by the looks of it nearly tripling his money in ten years. The guy who purchased in 2005 and held until today is still underwater on that same house over a decade later. One was a great investment, the other terrible.

Buy low, sell high. Pretty simple stuff

[lob]

dont take on debt,,,, unless it makes money in the long term .... u cant afford it dont buy it.... dont spend more than u earn. all common sense. once u get on top of it all , the money just rolls in..

Most people need to take on debt to get anywahere... debt for education and training; debt for a house; debt for a car... these are the norms that get people up and out of their bedrooms at 18 and set up for prosperity. Though I'm not entirely sure about whether apprenticeships are better than higher ed, some companies are starting to do hybrids, which is obviously desirable to help a nipper get started without crippling lifelong debt (even if UK student loans are probably the cheapest debt on the planet).

i reiterate.

dont take on debt,,

unless it makes money in the long term

[tomcat]

dont take on debt,,
unless it makes money in the long term

probably a good idea...

[CaptainNemo]

dont take on debt,,,, unless it makes money in the long term .... u cant afford it dont buy it.... dont spend more than u earn. all common sense. once u get on top of it all , the money just rolls in..

Most people need to take on debt to get anywahere... debt for education and training; debt for a house; debt for a car... these are the norms that get people up and out of their bedrooms at 18 and set up for prosperity. Though I'm not entirely sure about whether apprenticeships are better than higher ed, some companies are starting to do hybrids, which is obviously desirable to help a nipper get started without crippling lifelong debt (even if UK student loans are probably the cheapest debt on the planet).

i reiterate.

dont take on debt,,

unless it makes money in the long term

...ah you've got a rider in there, to agree with the OP, essentially.

[CaptainNemo]

People keep saying that... guess how long this website has been saying that for?
House price news, information and discussion - HousePriceCrash.co.uk

All that chart proves is that housing rises over a long enough time frame. Take a chart of the prices of ground beef or basically anything else and you get the same curve. It doesn't mean there aren't terrible times to buy a house.

Where you you rather buy on that chart, 1995 or 2005? Because the guy who purchased in 1995 and sold around 2005 got rich, by the looks of it nearly tripling his money in ten years. The guy who purchased in 2005 and held until today is still underwater on that same house over a decade later. One was a great investment, the other terrible.

Buy low, sell high. Pretty simple stuff

as is the p/e ratio... you can see now that it's hit a ceiling since extra regulation had to be introduced to prevent Gordon Brown's economic crisis happening again; but all the mass immigration is what is underlying the growth here - this not economics but politics.

[redhaze]

as is the p/e ratio... you can see now that it's hit a ceiling since extra regulation had to be introduced to prevent Gordon Brown's economic crisis happening again;

Its hit a ceiling because stocks are incredibly overvalued. This is sell time on that chart for stocks. But people won't sell because they are greedy, they forget the past, they want to believe in fairytales, or whatever.

Some people will sell though. And then they'll buy at the next crash. And it won't matter if they time it perfectly or even miss by a year or two, they'll make money while others will lament what always seems obvious in hindsight.