Reading books, articles, etc. on retirement planning is like putting together a jigsaw puzzle with most of the pieces missing. To help me make sense of it all I started to write notes. These notes provided details on the what, the how and the why of Marina and my's retirement planning process. As I talked with my friends about the contents of those notes I found that although nobody had exactly the same financial situation as Marina and I, nevertheless, there were more than enough similarities for each of us to learn from the experiences of the other. It was this realization that inspired me to start writing a series of articles on how we have gone about our retirement planning process. This article is the introduction and outline for that series.
I am not an economist or a financial planner and I don't play either one on television. That's why I don't give out financial advice. The purpose of these articles is strictly to share my wife and my's experiences in planning our own retirement so that others can see how a real life couple handled these issues and maybe get some inspiration, even if only to say 'wow, I'd never do that!' If, however, you run across something in these articles that looks like financial advice I'd appreciate it if you could use the comment feature at the bottom of the article's page to let me know so I can fix the offending text.
In fact, I hope lots of folks will use the comment features in order to provide feedback, requests for clarification, alternate views, etc.
Who We Are
Marina and I are in our early 30s and our first child is due early next year. I work in the software industry and Marina is a Pharmacist. We are both compulsive savers and have both been saving in 401(k)s, 403(b)s, IRAs, taxable savings, etc. since we started working. We expect to retire several decades from now.
A Financial Autobiography?
"Financial Autobiography" was the best phrase I could come up with to explain what I'm trying to do with these articles. These articles are a testimony, not a textbook. I am stating what we did, not what anyone else should do.
I have broken our retirement planning process into a series of steps that I outline below. Each step will itself be made up of a series of articles that I will post on my website.
Introduction – You're reading it!
Recommending Reading – Two books that I found very useful in matters financial
How I Learned To Stop Worrying and Love Finance – How we deal with uncertainty in our financial planning
Two Words: "Financial Planner" – Why I didn't just use a Financial Planner
The Times They Are A Changing – Quick thought on innovations in finance
Step 1 – Calculating How Much Money Is Currently Available For Retirement
In this section I walk through a variety of things that Marina and I are saving for, e.g. cars, houses, emergency funds, etc. I quantify how much we need for those goals and subtract that from our available assets, the remainder is what we have available for retirement. I also look into the issue of social security and short term money management. There is a spreadsheet that goes with this section. A lot of the material in this topic was inspired by [GFL].
Defined Benefit Assets – What we intend to do with Social Security, Pensions and Fixed Annuities
How Much Is That Housey In The Window? – The role of housing in our retirement plans
Step 2 – Planning a Minimum Retirement
I spend most of my time planning for a bright future filled with successful stock markets and happy societies. But anyone who has studied financial history knows, it's smart to have a plan B. Our plan B is taken from [ZMW] and we call it our 'minimum retirement'. The minimum retirement fund consists of super safe inflation adjusted investments like Treasury Inflation Protected Securities (TIPS). In this section I'll go through the gory details of figuring out exactly how much we think we will need to meet our 'minimum retirement' goals, figuring out where we think we should put the money (mutual funds? individual bonds?) and how much money we think we will need to save each year to achieve our goals. This section will include the fairly trivial algebra we use to calculate how much we need to spend each year on our minimum retirement.
Step 3 – Planning a Comfortable Retirement
Figuring out how much money we need to have a comfortable (as opposed to minimum) retirement turns out to be tricky. In this section I'll look at issues like our expected final income, average retirement spending amounts, expected growth in income, etc. All of which we use to figure out what our retirement goals actually are. I'll also look at how we intend to save for retirement (hint: we intend to save a fixed percentage of our income every year from now until retirement), how we intend to pull money out at retirement as well as our expectations for long term stock and bond returns. [TRS] and [GTS] were the main inspirations for withdrawal rates. [FPI] was the main inspiration for the stock and bond return estimates.
Step 4 – Picking Asset Classes and Their Relationships
What are asset classes? What are asset types? Is a TIPS a bond or a separate asset class? Do REITS provide much real estate exposure? Should we use a globally balanced stock portfolio? Are mortgage backed securities a good idea? What about whole bond market funds? What should our stock/bond balance be? This section explores how we struggled with these questions and what answers we came up with for ourselves. [BEF], [FPI] and [RWD] are the main inspirations for the content in this section with a lot of back up from academia.
Step 5 – Picking Prospective Investments
Theory is interesting but retirement is built on specifics. This section will turn the theories of the previous section into a list of assets (e.g. specific mutual funds, bonds, stocks, etc.) and our best guess at the best asset locations (e.g. IRAs, taxable accounts, annuities, etc.) to place them in.
Step 6 – Asset Location
The previous section provides a shopping list of possible asset/asset location combinations (e.g. an EMEA index in a 401(K)) but the total number of reasonable combinations is large and so some winnowing is called for. This section provides a bunch of algebra that shows how we model an asset's expected behavior when placed in a particular asset location. Using this data I then specify a set of heuristics we use to prioritize how we spend our retirement money.
Step 7 – Calculating The Constant Savings Percentage (CSP)
This is where all the previous sections come together to figure out exactly what percentage of our salaries we think we should save each year in order to meet our retirement goals. This section builds up the math to create a simulator that spits out the 'answer' This section will also discuss why the simulator shouldn't be treated very seriously. If all goes well I will release a Java implementation of the simulator.
Step 8 – Portfolio Averaging
Portfolio averaging is a name I came up with to describe how I try to keep our portfolio in balance, which is that as new money comes in (or as we get dividends/interest) I allocate the new money in a way designed to keep the portfolio as close to balance as possible. This section provides the math and Java code for a program that takes the current state of a portfolio along with available cash and calculates how best to allocate that cash to meet portfolio balancing goals without rebalancing.
I don't have much in the way of notes yet on issues such as re-balancing (if portfolio averaging fails) as well as more advanced portfolio management strategies such as tax harvesting. I intended to get to these areas eventually.
In the conclusion I'll mostly talk about changes I see coming down the road that I suspect will require changing the strategies outlined here. As I mentioned in the introduction, change is inevitable.
Appendix 1 – Dealing with Inflation
Although I do most of the math in these articles in real terms (i.e. in inflation adjusted dollars) from time to time I need to deal with inflation. This section walks through my possibly flawed understanding of the math of how to calculate the rate of inflation, how to adjust returns for inflation and especially how to adjust interest or capital returns for inflation.
Appendix 2 – Background on Playing with Stock Indexes
Stock indexes make up a huge portion of our retirement portfolio so I have more than a little interest in them. In this section I talk about the different kind of stock indexes available, how they are calculated, etc. I then identify indexes that are available on-line that I use frequently.
References For This Article
[BEF] Bernstein, William J., Sharin, Susan F., "Efficient Frontier – An Online Journal of Practical Asset Allocation", http://www.efficientfrontier.com/ef/index.shtml.
[FPI] Bernstein, William J., "The Four Pillars of Investing: Lessons for Building a Winning Portfolio", McGraw-Hill, 4/26/2002.
[GFL] Kobliner, Beth, "Get A Financial Life: Personal Finance In Your Twenties And Thirties", Fireside, 6/6/2000.
[GTS] Greaney, John P., "The Retire Early study on safe withdrawal rates.", June 1, 2000. http://www.retireearlyhomepage.com/restud1.html.
[RWD] Malkiel, Burton G., "A Random Walk Down Wall Street, Completely Revised and Updated Edition", W. W. Norton & Company, 12/4/2003.
[TRS] Cooley, Philip L., Hubbard, Carl M. Walz, Daniel T., "Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable", AAII Journal, February 1998. http://bobsfiles.home.att.net/trinity.htm.
[ZMW] Bodie, Zvi, Clowes, Michael J., "Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals", Prentice Hall/Financial Times, 2003.