WARNING: This is still a draft. Please post comments with questions and suggestions.
In this section we’re going to start at the end and work backwards to figure out how to get there.
For most people, financial planning is about retirement. That’s why your employer provides a 401k plan, that’s why the government has social security, that’s why people get pensitions. Retirement will be our focus.
The first thing I did was to figure out how much money I would need to live on when I’m retired. Then I could work backwards and figure out how to get there. (Footnote: That’s a bit of a lie. I didn’t think to do this until years into the process. That was a mistake I made, that you can avoid.)
I’ll skip to my conclusion:
Plan A: If we (my spouse and I) have $4m in the bank at retirement, every year we should make about $160k in interest, assuming a very low-risk investment. If we only spend this interest, my partner and I can live very well. Best of all, since we aren’t spending any of the $4m principal itself, we’ll be able to live forever and still have $4m in the bank. Or, if we die (a likely occurance), we’ll be able to leave $4m to the charity of our choice (since we have no children).
Plan B: If we have $2m in the bank at retirement, the first year we’ll make 80k in interest. We can probably live off that, but we’d need to spend some of the $2m principal. That means that the second year of retirement we’d have less than $2m, so our interest will be less, and we’ll need to pull even more from the $1.9m principal. By our math, we’ll be able to do this until we turn 90 years old, at which point we’ll be pennyless. Based on various “life expectancy calculators” we’ll probably be dead by then, so that’s ok. If we time it right, we’ll die exactly when the balance reach zero, and my last check will pay for my funeral, which will bounce.
Therefore my retirement goal is:
- Plan A: $4 million: Aim to have $4m at retirement (and live forever)
- Plan B: $2 million: …but if I miss the $4m target I’ll be ok as long as I accumulate $2m and die by age 90
Realistically I’m going to strive for $4m, but as long as I reach $2m then I’m set.
Some day you’ll hire a personal financial advisor and they’ll do this math for you. They’ll figure out the correct amounts for your calculation. However for us it was about four and two million.
Until you hire a personal financial advisor, you can do the rough
math yourself: Assume that when you retire you’ll probably be
able to make 4% interest on your money. Figure out how much
money you’ll need to live on each month, multiply that by 12 (for
the yearly amount), and multiply that by 1/0.04 to calculate how
much money you’ll need to have such that 4% interest will result
in this amount. The 0.04 in that formula represents 4%.
1 / 0.04 = 25; therefore the amount you’ll need is the yearly amount multiplied by 25.)
Note: 4% return on investment is pretty optimistic. You can change the formula to be 2% or 3% if you want to be more pessimistic.
Note: I’m unsure if Social Security will still be around when I retire. I fully expect the GOP to succeed in fucking up the single most successful government program ever invented. It’s a bigger achievement than eliminating polio and putting a man on the moon combined. Before Social Security, the typical ederly person lived in poverty. The news used to have articles about people discovering an elderly neighbor was eating dog food because it was cheaper than groceries. That kind of poverty! You haven’t seen that kind of story in ages. Why? Because Social Security fucking works. I truly hope that Social Security will be saved by the Democrats, but considering that the Republicans have spent 30 years trying to sabbatge social security with happy sounding proposals like “privitization” it makes me concerned that they will win by intertia. I promise to write a blog post about this later. Until then, you can create an account on www.ssa.gov and see how much you’ve contributed to Social Security, and how much you’ll get out each month assuming the system isn’t destroyed.
From debt hole to your retirement goal
Now that I know the goal ($4m …or at least $2m) how can I possibly get there if I am $40k in debt?
First I needed to get from $40k in debt to zero. Then I would go from zero to $4m.
Sounds simple, right?
No, it was terrifying. When you are $40k in debt, saving up to $4m is impossible. My solution was to procrastinate since “there’s nothing I could do.”
Ugh. That was stupid.
In hindsight I should have started early with debt reduction and investment as soon as possible… even if that meant saving money by packing my own lunch instead of eating at the company cafeteria. (You folks with free lunch at work should consider one less Starbucks coffee a day… that’s $250 you’ll have for debt reduction or investment every month; or just cook at home 1-2 times a week more often than you currently do and you’ll probably have an extra $200 to play around with!)
Let’s briefly talk about debt: There is toxic debt (credit cards) and “good debt” (home mortgages… because we are going to assume you can sell your house for at least what you paid; i.e. home mortgages are an investment). Student loans are good debt because they improve your chance of a good career… they are an investment in yourself. However since they don’t have cash value (like a house) we want to get rid of them quickly too.
I’m only going to concern myself with the toxic and student debt. The mortgage debt we can ignore until we have a financial advisor.
Going from $40k in debt to $4m in savings means acquiring $4,040,000 ($40k to zero then zero to $4m). That’s not possible in your lifetime. It would mean putting aside $8416 every month of your career (assuming you work from age 22 to age 62). That’s crazy. You probably don’t make that much now, and definitely didn’t make that much right out of college.
Luckily you don’t have to do that.
It turns out the power of compound interest means the money you save will double approximately every 7-10 years (assuming a reasonable investment strategy). The money you save in your 20s will double many times by the time you retire. So, if you save an appropriate amount in your early (low-earning) years it will earn you more than the savings in your last years. In other words, saving early is more important than trying to catch up later.
That’s a very long-winded way of saying this good news: You don’t have to save $8416 every month. You can save a smaller amount and let compound interest do the rest. The IRS’s terminology for interest is “unearned income” which is a technical way of saying “making money while you sit on your ass.”
Ok, so you are going to invest a small amount of money every month. This will either go to eliminating your debt, or saving for retirement.
But you’re broke so… where will this money come from?
Where does the money come from? A few sources. I’ve already mentioned that $200-300/month you give to Starbucks. In the next chapter we’ll see you have an even bigger, and better, source.
Speaking of Starbucks: Buying a fancy, sugar-filled, Starbucks coffee every day is about 12,000 calories per month. By comparison, a pound of fat is 3,000 calories. You’ll need to run about 30 miles to burn off 12,000 calories per month or you’ll slowly gain weight over time. Skip the fancy coffee and you’ll be richer and thinner.
In the next post we’ll talk about how to get out of debt.