You know, there's a lot of advice floating around out there.
Recent conversations with friends have pointed out several commonly held beliefs about best practices. I've decided that these are for people who aren't able to truly take the reins of their own financial future. And honestly, that's not a bad thing for some people. It would've been good advice for me once upon a time.
Thankfully, God has allowed my path to deviate from the norm. Studying business and accounting really made a huge impact in how I think about money and numbers. Studying the Bible has made a huge impact on the balance between material wealth and spiritual wealth.
If you're willing to dive in with me, I'd like to discuss some of these commonly held beliefs and fetter out the reality.
1. Pay off your smallest debt first.
Paying off debt is a phenomenal idea! It's second to not taking on debt in the first place. But even I agree with debt sometimes. I would never go back and not take student loans. To do so would've been to delay my education which has made many more things possible. I'm not sure I'd even go back and not take a mortgage for my home. I might wish that I had made better decisions leading up to the mortgage.
So, what's wrong the idea of paying off small debts first? One word: Interest.
It takes a little more time and brain power to consider the long-term effects of debt. Which is going to cost more in the long-run: $10,000 for 10 years at 6% or $2,500 for 5 years at 4%?
Repaying the $10,000 will cost you $13,322.46. Repaying the $2,500 will cost $2,762.48. I'd rather reduce the amount of interest I'm paying on the $10,000 before putting any extra to repaying the $2,500 sooner.
I know many people who will take their income tax return each Spring and put it toward whichever debt it will pay off without consideration of the interest rates. The difference is astounding. If you can continue to make your minimum payments, please put that money toward the debt with the highest interest rate.
The long-term effect is to have less money spent on repaying debt. That leaves more money for investments, etc.
2. The 4% retirement rule
To retire well, I should be able to live on 4% of my retirement portfolio. Wow! That would have to be a reallllllly large portfolio.
Ok, ok. Before I really dig into why I so strongly dislike this idea, let's talk about where it came from and what it means. Because, of course, for someone out there this is the best idea.
Back in 1994, a financial advisor by the name of Bill Bengen came up with the idea that if you had a decent mix of stocks and bonds by retirement age (when you're drawing Social Security), that you could withdraw 4% of your portfolio per year to have a healthy retirement income for the remainder of your life (approximately 30 years). The 4% would include some interest, some dividends, and some sales of capital.
Sale of capital... therein is my issue. What sort of investments require you to sell capital to make money? And why don't the dividends being paid equate to more than 4%?? All of my portfolios, even the low-risk, new baby portfolio, have over 4% annual yield right now!
Well, it has a lot to do with the other assumption 60% of this type of portfolio is in stocks and 40% is in bonds. Let's start with the bonds portion of this portfolio. Bonds tend to pay interest close to the current interest rate. What's the current interest rate today? It's less than 1%, right? And what's the currently annual inflation? It's over 1%. So, 40% of that portfolio is probably losing money off the top to inflation (because it's worth less than it earns each year). Then the 60% in stocks probably contains enough stock that doesn't pay any dividends that it's solely reliant upon the stock price going up to earn money.
Let's not even mention the fact that this strategy leads to a smaller portfolio each year. Also, do you really want to wait until you can draw social security to live off your retirement portfolio?
It makes me think of the parable of talents and that one guy who stuck his master's money in the ground. Let's be smart and put Our Master's money that He's entrusted us into something that will at least earn more than the annual inflation rate.
Here are some real number examples:
Today, Bob has accumulated $500,000 for his retirement. He wants to know when he can retire. He decides to email his favorite investment blogger for some advice. He asks "Should I follow the 4% rule for retirement?"
The answer he gets is very surprising. He is told that if he were to retire today using the 4% rule he would have an income of $20,000. If he waits 10 years it will be close to $36,000 per year, and if he waits 20 years, $64,000. However, if he were to take the same amount and allocate it across some dividend investments with an annual yield of about 4% and average growth rates, he would have an annual income of $20,000 today, $55,000 if he waits 10 years, and $163,000 if he waits 20 years. However, if he wants to start drawing the $20,000 a year income today from the dividend investments (rather than reinvesting the dividends), his annual dividend income would still increase to $36,000 in 10 years and $64,000 in 20 years.
3. Max out your retirement savings
I think this is a perfect topic to follow Bob's example above. If you were to max out your retirement savings each year, how much would you have by now? Maybe you'd have as much as Bob, or maybe not. However much you've put into a retirement vehicle (401K, 403B, IRA, etc.) is how much money you can't touch until you're old enough. Queue MC Hammer singing "Can't touch this!"
I know of many people who are following the general beliefs about retirement and work, and are slaving away at jobs they hate so that they can retire well when they are in their 60s or 70s. My question is why?
As a follower of Jesus, I firmly believe in the call to "Rejoice in the Lord always!" (Philippians 4) This means doing work I love, spending time with people I love (even if I have to remember to love them as Christ loves them), and living for something eternal.
I'm pretty sure the measly amount that I have in my retirement savings is plenty to sustain the additional I'll need when I'm retirement age. They key is in 'the additional'. I really don't think I'll need more than 15-20k extra once I can withdraw from a retirement account without penalty. I keep my expenses low now with no plans to do anything but decrease them over time (pay off the house, wipe out the student loans) and I'm increasing my regular income by investing my savings into dividends. The other great part about my current income is that whether my dividends are qualified or not, the tax bracket I'm in is laughably small.
So, what would happen if I put all my extra savings into a retirement portfolio? It would be locked away for another 20+ years. That's 20 years of which I could be drawing dividend income or growing future dividend income.
My advice is simple, if you can manage your money well and plan for the future, put into retirement savings what you will need in the future minus what you will receive from other passive income sources. Dividends are GREAT! They allow your little dollars to go to work every day and bring home a regular (monthly/quarterly) paycheck or multiply into new little workers.
That's all from my soap box today. Maybe next time I'll address my views on tax-deferred savings.
Recent conversations with friends have pointed out several commonly held beliefs about best practices. I've decided that these are for people who aren't able to truly take the reins of their own financial future. And honestly, that's not a bad thing for some people. It would've been good advice for me once upon a time.
Thankfully, God has allowed my path to deviate from the norm. Studying business and accounting really made a huge impact in how I think about money and numbers. Studying the Bible has made a huge impact on the balance between material wealth and spiritual wealth.
If you're willing to dive in with me, I'd like to discuss some of these commonly held beliefs and fetter out the reality.
1. Pay off your smallest debt first.
Paying off debt is a phenomenal idea! It's second to not taking on debt in the first place. But even I agree with debt sometimes. I would never go back and not take student loans. To do so would've been to delay my education which has made many more things possible. I'm not sure I'd even go back and not take a mortgage for my home. I might wish that I had made better decisions leading up to the mortgage.
So, what's wrong the idea of paying off small debts first? One word: Interest.
It takes a little more time and brain power to consider the long-term effects of debt. Which is going to cost more in the long-run: $10,000 for 10 years at 6% or $2,500 for 5 years at 4%?
Repaying the $10,000 will cost you $13,322.46. Repaying the $2,500 will cost $2,762.48. I'd rather reduce the amount of interest I'm paying on the $10,000 before putting any extra to repaying the $2,500 sooner.
I know many people who will take their income tax return each Spring and put it toward whichever debt it will pay off without consideration of the interest rates. The difference is astounding. If you can continue to make your minimum payments, please put that money toward the debt with the highest interest rate.
The long-term effect is to have less money spent on repaying debt. That leaves more money for investments, etc.
2. The 4% retirement rule
To retire well, I should be able to live on 4% of my retirement portfolio. Wow! That would have to be a reallllllly large portfolio.
Ok, ok. Before I really dig into why I so strongly dislike this idea, let's talk about where it came from and what it means. Because, of course, for someone out there this is the best idea.
Back in 1994, a financial advisor by the name of Bill Bengen came up with the idea that if you had a decent mix of stocks and bonds by retirement age (when you're drawing Social Security), that you could withdraw 4% of your portfolio per year to have a healthy retirement income for the remainder of your life (approximately 30 years). The 4% would include some interest, some dividends, and some sales of capital.
Sale of capital... therein is my issue. What sort of investments require you to sell capital to make money? And why don't the dividends being paid equate to more than 4%?? All of my portfolios, even the low-risk, new baby portfolio, have over 4% annual yield right now!
Well, it has a lot to do with the other assumption 60% of this type of portfolio is in stocks and 40% is in bonds. Let's start with the bonds portion of this portfolio. Bonds tend to pay interest close to the current interest rate. What's the current interest rate today? It's less than 1%, right? And what's the currently annual inflation? It's over 1%. So, 40% of that portfolio is probably losing money off the top to inflation (because it's worth less than it earns each year). Then the 60% in stocks probably contains enough stock that doesn't pay any dividends that it's solely reliant upon the stock price going up to earn money.
Let's not even mention the fact that this strategy leads to a smaller portfolio each year. Also, do you really want to wait until you can draw social security to live off your retirement portfolio?
It makes me think of the parable of talents and that one guy who stuck his master's money in the ground. Let's be smart and put Our Master's money that He's entrusted us into something that will at least earn more than the annual inflation rate.
Here are some real number examples:
Today, Bob has accumulated $500,000 for his retirement. He wants to know when he can retire. He decides to email his favorite investment blogger for some advice. He asks "Should I follow the 4% rule for retirement?"
The answer he gets is very surprising. He is told that if he were to retire today using the 4% rule he would have an income of $20,000. If he waits 10 years it will be close to $36,000 per year, and if he waits 20 years, $64,000. However, if he were to take the same amount and allocate it across some dividend investments with an annual yield of about 4% and average growth rates, he would have an annual income of $20,000 today, $55,000 if he waits 10 years, and $163,000 if he waits 20 years. However, if he wants to start drawing the $20,000 a year income today from the dividend investments (rather than reinvesting the dividends), his annual dividend income would still increase to $36,000 in 10 years and $64,000 in 20 years.
3. Max out your retirement savings
I think this is a perfect topic to follow Bob's example above. If you were to max out your retirement savings each year, how much would you have by now? Maybe you'd have as much as Bob, or maybe not. However much you've put into a retirement vehicle (401K, 403B, IRA, etc.) is how much money you can't touch until you're old enough. Queue MC Hammer singing "Can't touch this!"
I know of many people who are following the general beliefs about retirement and work, and are slaving away at jobs they hate so that they can retire well when they are in their 60s or 70s. My question is why?
As a follower of Jesus, I firmly believe in the call to "Rejoice in the Lord always!" (Philippians 4) This means doing work I love, spending time with people I love (even if I have to remember to love them as Christ loves them), and living for something eternal.
I'm pretty sure the measly amount that I have in my retirement savings is plenty to sustain the additional I'll need when I'm retirement age. They key is in 'the additional'. I really don't think I'll need more than 15-20k extra once I can withdraw from a retirement account without penalty. I keep my expenses low now with no plans to do anything but decrease them over time (pay off the house, wipe out the student loans) and I'm increasing my regular income by investing my savings into dividends. The other great part about my current income is that whether my dividends are qualified or not, the tax bracket I'm in is laughably small.
So, what would happen if I put all my extra savings into a retirement portfolio? It would be locked away for another 20+ years. That's 20 years of which I could be drawing dividend income or growing future dividend income.
My advice is simple, if you can manage your money well and plan for the future, put into retirement savings what you will need in the future minus what you will receive from other passive income sources. Dividends are GREAT! They allow your little dollars to go to work every day and bring home a regular (monthly/quarterly) paycheck or multiply into new little workers.
That's all from my soap box today. Maybe next time I'll address my views on tax-deferred savings.
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