So my girlfriend asked me the other day to come over to talk about investing and retirement.  I thought, WHO ME?  What do I know about such things?  Ask me something about architecture.  Or babies.  Or maybe the Hobbit.  My younger son is a bit obsessed at the moment with the Bagginses.  No?

I was actually surprised that I knew a little more than I thought. Not enough for a 101 class, but enough to be more than nothing.  Please don't substitute this for professional advice.

So.  Here 'goes.

Review of Dave Ramsey's Baby Steps:

image courtesy of  Tax Credits
0. [Stop overspending!] and get current with all creditors; make a budget
1. $1000 to start an emergency fund
2. Pay off all debt (except the house) using the “Debt Snowball,” paying off the SMALLEST 1st
3. 3 – 6 months of expenses in savings (a full emergency fund)
4. Invest 15% of gross household income into Roth IRAs and pre-tax retirement
5. College & mission funding for children
6. Pay off home mortgage early
7. Build wealth and give


How Much To Contribute

Step four (above) tells you how much to invest in retirement savings =
15% of gross income.

Using the AARP calculator (for comparison), we found that if we just maxed out our Roth IRAs every year @$5500/ea, we'd stay out of the poor house.
Note: AARP does assume in its calculations that Social Security will be around to supplement.

Limits on Tax-Friendly Accounts

If you have access to a 401(k) plan through an employer with matching, definitely take advantage of that.  We haven't since I quit my job to raise our children in 2005, and I get the impression these benefits are getting scarce.  If you do 401(k), be sure not to exceed the limits there, too. (I think currently at $17K per person per year.)
If you are saving more than allowed in the IRAs, you'll need additional non-retirement accounts to store your money, and you'll get no tax breaks there, so you'll need to make greater gains to equal the tax free accounts.

Asset Allocation: Stocks, Bonds & Cash

A typical approach is this formula:
110 - age = % of stocks in portfolio*
For me, the recommendation is 110 - 42 = 68% stocks, the rest in bonds & money market accounts.

  • Stocks are for growth, but can be risky.  
  • Bonds, money market & Cash are for stability.  

The older you get, the less you're supposedly willing to risk (because you'll be withdrawing from your accounts rather than building them up).
CNN Asset Allocation
Forbes Asset Allocation Calculators
Vanguard’s version
*this number used to be 100, but has been increased to 110/120 because more people are retiring later.

Investment Approach

Almost everything I read lately says for the current market, put your stocks in index funds.  You get the benefit of overall market, without having to pay the fees associated with mutual funds.

This is an older article, but it still applies.  A quote from the end reads,
"But which one is best for you? The truth is, any one is better than wasting your time chasing hot stocks and the other 8,000-plus actively managed funds, 80-85% of which underperform the market every year."

Here's a more recent article referencing laissez-faire investing called "Sit-On-Your-Hands Stocks."

Tax Strategy

IRA vs. Roth IRA.  With IRAs, you avoid taxes when you put the money in; with Roth IRAs, you avoid taxes when you take the money out in retirement.  There are income limitations on Roth IRAS (currently $183K/year for married couples).  These accounts will likely grow, so tax-wise, it's typically better to choose the Roth.  HOWEVER, also consider when you will be at a higher tax rate.  If you're making big bucks now & plan to retire on a modest income, the traditional IRA may be for you.

Tax-free municipal bonds & bond funds are great for traditional IRAs, but are a waste for Roth IRAs, whose gains are tax-free no matter what.

Target Nest Egg 

I really love that Dave Ramsey's suggestion is not a Target Nest Egg number, but a simple calculation of how much to contribute NOW.  It's certainly the most important step: getting in the habit of contributing.

But what if you're starting your 15% contribution a bit late?  Once you've established the 15% habit, how do you calculate your additional contribution?

You can retire when you have 25x your annual expenses invested in income generating assets*. 

For example, if my annual expenses are $50,000 then my target is $1,250,000.  If I am making 4% interest on that target nest egg every year, then I have $50,000 per year to live off of.

*“Income generating assets” are things like stocks, bonds, CDs, businesses, real estate, etc.  Savings accounts that make less than 4% do not count.  Neither do primary residences, which do not generate income.
**A 4% rate is assumed to generate annually from these investments.  You live off the 4% but do not touch the principal.  In theory, if you can reach this target, you could live until 100 or 1000, your 4% will keep coming.

This calculation is based solely on expenses***, so reduce them.  If you can pay off your mortgage**** and/or debts before retirement, then your annual expenses go down considerably... and your target nest egg can be reduced $25 for every dollar of expense eliminated.

***Not everyone will tell you this.  For example, Voya calculates "orange money" based on income, not on expenses. (3/2015)  This is misleading.  
****If your target retirement is age 65, and you get a new thirty-year mortgage at age 45, you'll have to pay it down very aggressively.  Consider instead a 15 year mortgage, which will get you a better rate, anyway, and you'll be done when you're 60.

Of course, the actual calculation is a bit more complicated.  Rates of interest and income on properties fluctuate, inflation eats away at savings, nest eggs are designed to grow in value, and your expenses might rise as you age.  But as many of these cancel each other or average out over time, this simple calculation is a good place to start.



p.s. Obviously, this post is only marginally related to zessn topics of affordable architecture, but it's not as if any of these topics exist in a bubble.  Overall financial health is necessary for any sort of architectural budget!