Tuesday, February 06, 2007

Thoughts on investing

Disclaimer: Do your own research and think for yourself. Assume I’m an idiot and I don’t know what I’m talking about. You still might come to the same conclusions I do, but at least you’ll know why you believe it.

Let’s talk about saving for retirement for a bit. Everyone seems to ask, “How much should I save?”. The answer is simple. Half.

HALF!?!

Yes, half. Well maybe a third. Okay, let’s think about it. First and foremost, a key assumption here is that whatever you save will grow at about the rate of inflation. The bottom line is that the money you put away doesn’t REALLY grow when you take inflation, fees, expenses, and capital gains taxes into account. The only way around this assumption is for you to beat the masses. Clearly, everyone can’t beat everyone else on their rate of return. You can’t count on somehow beating the odds.

So what does that mean? Well, in the words of the Mogambo Guru, "Mathematically, with real (inflation-adjusted) net gains of zero, to get a hamburger in the future, you have to save a hamburger today."

If you work it all out, you’ll come to the conclusion that if you live on half of what you take home, you can have a day of retirement for every day of work If you’re going to work twice as long as you plan to spend in retirement, then you can afford to live on 2/3 of what you take home.

So, if you’re in your 20’s and plan to work for 40 years and retire for 20 (and you want to live like you do now in retirement), you’d better be socking away the equivalent of 33% of your “spending budget” every month. If you want to work for 30 and retire for 30, your retirement savings better be equal to half of what you spend. Make sense?

Now hopefully you’ll have your house paid off before you retire, so that’ll free up some cash, but chances are you’ll be replacing that expense with old-age related expenses so don’t get too excited.

So I guess we'd better either get saving, or come up with a way to beat inflation and taxes.

3 Comments:

Blogger Sailorcurt said...

Thanks, now I'm throughly convinced that I'm screwed.

If only I had started thinking about retirement when I was young and knew everything. Now I'm older, don't know as much and am barely getting started on my retirement accounts.

Oh well. I guess I can just pray for good health until I die because it looks like I'll be working until then.

February 06, 2007 12:45 PM  
Blogger aughtSix said...

Isn't the long term average return on the stock market something on the order of 7% per year? Inflation would take a non-trivial chunk out of that, but not so much that you'd only break even. I'm in my early twenties, and I'm sure expecting each dollar I save this year to grow into more than one dollar (in real terms) by the time I retire, whenever that may be. If that weren't the case, then it'd be a lot easier to "catch up" on retirement. The thing you lose by starting late is all that compound interest you could have gotten on the money you didn't save when you started working.

February 06, 2007 1:45 PM  
Blogger Reason said...

Don't forget that inflation compounds the same way growth does. To figure your real growth, you have to consider inflation and fees up front, and taxes when you take the money out (assuming 401k).

If you make 7%, but give up 4% to inflation and 1% to fees, and then get taxed at only 15% when you take it out, your REAL GROWTH is less than ONE PERCENT! If you're in the 25% tax bracket, you barely break even! Wanna guess what happens if you're taxed at 35%? You're averaging a 1% LOSS every year compounded over the years you work.

Add to this my dim view of the future of the stock market (read, "lower average returns"), and you've got some motivation to find a better way of doing things.

February 07, 2007 6:42 AM  

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