Retirement ideas from reading Bogleheads Guide to Investing

I figured with our current money situation, I could do with a refresh on retirement planning ideas.  You know, things that I used to ignore because we weren’t there yet like what to do with long-term money outside of retirement accounts or how to get more diversification once you have room to play with things that aren’t just the basics.

So I checked out Bogleheads Guide to Investing (all amazon links are affiliate).  (I actually own Bogleheads Guide to Retirement, but it is more scattered and not as useful.)  I skipped several chapters because like… I know low fees are important, I understand the basics of diversified portfolios using a small number of low-cost indexes etc.  Those are important, and they’re really all most people need to know– once you have that down and have enough money to put it into action, you’re likely going to have a nice retirement.

But right now we’re at a point in which adding to a Target-date fund doesn’t make sense– we have enough money set up for safety.  (I’m not saying that we could stop contributing to retirement, but we are at the point where if we keep doing what we’re doing we will be fine.)  And we have possibly too high of a percentage in the US Vanguard Total Stock Index because in some of our retirement accounts that was the cheapest broad-based fund in a sea of expensive alternate options.  (It’s also a really great choice on its own!  But a little more diversification at this point would not go amiss.)

What happened to cause this decision to go back to basics?  We had some extra money in savings that we hadn’t spent down when DH got re-employed, so I figured we should put it in taxable stocks since there wasn’t really anywhere else to put it.  I was like, maybe I should get more Nasdaq because historically I’ve tried to balance riskier stock indexes/ETFs with safer ones like the Dow or just the S&P 500.  (Back in the day!)  But then I had a hard time finding a cheap index and didn’t feel like dealing with the ETF aspects of QQQ (which is really just simple math– this is me not at all being logical).  And then I was like, if I’m going to have to think about this at all I might as well do a little more thinking.  So I thought… hey, this is a taxable fund, why don’t I buy some tax-advantaged Muni Bonds.  Which is adding LESS risk to the portfolio instead of more!  But also, I didn’t have any tax-advantaged bonds in taxable accounts, and it seemed reasonable to get some at this point since we have a sensible retirement plan locked up in our retirement accounts.  So I bought a Vanguard municipal bond fund.

At that point, I thought… I should get some rhyme and reason to these additions.  I shouldn’t be in a situation in which I go in to buy Nasdaq and end up buying municipal bonds instead.  That makes no logical sense.

So while I am really not wanting to go through all of our different accounts to figure out what’s small cap vs. large cap and so on, I really ought to at least figure out what we have in domestic vs. international, what we have in emerging markets, how much we have in bond funds and what kind of bond funds etc.

And it’s time to start thinking about increased diversification through funds that don’t just track the US stock or bond market and about increased tax advantaging via asset allocation.  Bogleheads makes it clear that these things are *OPTIONAL*.  If you’re not yet maxing out your retirement accounts, just stick to a Target-date fund or a mix of a total stock index and a total bond index based on your predicted retirement date and preferred asset allocations.

So things to think about:

munis (We now have some!  Bogleheads doesn’t seem to limit the amount but they do say that only people who have maxed out tax advantaged retirement should even consider these.)
REITs (They suggest no more than 10% of a portfolio should be this– currently our house is more than 10% of our total savings, so maybe we’re not ready for these yet.)
TIPS (we will probably never do this, but they recommend up to 40% based on where you are in retirement)
International funds (I have dipped into this, but I can’t remember where or how much.  Bogle says no more than 20%, but the book authors say 20-40%.)
Tax loss harvesting– I’m never going to do this myself because I will stick with broad-based indexes, but it is magical when it happens.  Still, it might be worthwhile looking into tax-advantaged funds to put in my taxable accounts.

I’m still not sure if it is better to have low yield/safer bond funds in taxable or tax-protected accounts.  The argument Bogleheads makes is that taxes on stocks that have been held a long time are currently capped at 15%, but they’re not capped for bonds.  The counter-argument is that the earnings on stocks are going to be a lot larger than the earnings on bonds, so it will be 15% of a larger number vs. whatever your tax rate is on bonds of a smaller number.  (And one’s tax rate in retirement could be 15%!  It’s hard to predict the future!)  Buying munis and putting those in taxable means that you’re not paying federal taxes so that kind of allocation is pretty obvious.

Several sections of the book have slightly different charts with most tax efficient vs. least tax efficient investments.  High yield bond funds (like junk bonds) should definitely only go in tax-advantaged (I think it is unlikely we will ever buy junk bonds since I prefer bonds to decrease, not increase, risk).  Then they say REITs should go in tax-advantaged, so that’s something I would eventually want to think about in terms of what Fidelity has to offer since that’s my work account.  Then balanced funds.  Then active stock funds (presumably because managers can realize losses?).  Then all the various stocks you can think of become more tax efficient, and finally low yield cash or cash equivalents.

Did you know that IRAs don’t get a step-up in cost-basis at death like taxable stocks do?  I did not!

Anyhow, this is just initial thinking– I do not have any recommendations for anybody yet including myself.  I do think that I need to come up with a plan though, otherwise cash will just sit in my saving account accumulating no interest until next summer.  I don’t get paid until October so I have a while to set out a strategy and I should do that before school starts up again while I have the mental space for it.

Next steps:
1. Update my asset allocation numbers (I have a spreadsheet, but I only tend to update when I log into the respective website, so I don’t have a snapshot of everything at any one point in time), especially the stocks vs. bonds percentages and the domestic vs. international percentages.
2. Think about how often I want to put money into taxable. Do I want every other month no matter what is in there? Do I want a benchmark of 10K or 30K over what I need for summer savings? I will also need to make sure we have enough for our backdoor Roths come January since those are tax-advantaged.
3. Related: I should figure out how much to put in the dependent daycare account for DC2. What will zie be doing next summer? I have no idea! Daycamp options in town aren’t the best for middle schoolers.  [Update:  decided just to go with the after school care costs and if daycamp happens we just won’t get tax credit for it.]
4. Figure out an investment strategy going forward based on diversification and what to put in taxable Vanguard vs. tax-advantaged Fidelity. (DH’s retirement option sucks so it’s all in their lowest cost S&P 500 and then my 457 is in its own weird thing we don’t have any choice over.)

How do you figure out your asset allocation?

Ask the grumpies: Time to retire?

CG asks:

How will you decide when it’s time to retire?

#1:  I am always ready to retire.  For me this will come down to money.  I will need enough money to keep myself in books and housing and food.

#2:  I don’t think I will…?  It will probably end up being a combination of life circumstances (like health) and job stuff.   I dunno.  I’m still in the taking it a week at a time mode.

Grumpy Nation:  How will you decide it’s time to retire?

Ask the grumpies: What do you want to do when you retire?

CG asks:

What do you want to do when you retire? My motivation for asking is I’m always interested in these people who retire at 40 or 50–they have a lot of time left if things go well and what kinds of things do they want to do or accomplish with their second act? This applies to people who plan to retire at a more traditional age as well.

#1 doesn’t really plan on retiring.  I don’t know what I would do.  I’m honestly not very good at being unproductive 100% of the time (I am very good at being unproductive on weekends) and I’m sure I would feel huge amounts of guilt if I weren’t doing something to make the world a better place.  Depending on the trajectory that the US ends up in, I would probably end up miserable trying to herd volunteer cats to fight the power.  The life of a professor in which I gently nudge students to think critically about their goals and how to achieve them while also removing their math phobia seems a lot better than that.  If the world was in a good place, I don’t know, probably go places to try eating new things, read more challenging novels than I do now, and watch youtube videos.  I’d probably also exercise more.  I would hopefully not waste too much time arguing with people who are wrong on the internet, but who knows.

#2 loves the idea of retirement and would read books, foster kittens, and travel to Italy to eat.  Also all the naps.

What should you do when your employer stops its retirement match?

Disclaimer:  We are not financial professionals.  Please do your own research and/or consult a professional before making important financial decisions.

Universities all over the country are temporarily suspending generous retirement fund matches.  Recently, the Fortune 500 company my sister works for decided to follow suit, which is ridiculous given that they’re not in dire straits and have been through worse.  (It makes sense when DH’s tiny company temporarily cuts the match, but a Fortune 500 company that’s built on keeping top talent with firm specific human capital AND wants to be able to gently let older workers go in a world without mandatory retirement… it’s ridiculous and very short-sighted.  I mean, maybe it’s helping them delay lay-offs… I would be more confident in their decision making if they hadn’t tried to make everybody come back into work in person after the initial quarantine was lifted even if they were productive at home or were in Covid danger categories.  But I digress.)

So what should you do if you are in this situation?

Part of the answer depends on how secure your job is.  If you’ve got tenure and you don’t think your uni is going to go completely out of business, or if you’re not in danger of being laid off from a large firm, then you need to make up the difference and contribute more to your retirement account.  If you’re worried about losing your job and being unemployed for a while and don’t already have a good emergency fund, then you might want to contribute the same or less to your retirement account (though if you are in this situation, you should see where you can cut spending and do a financial fire drill before you sign anything that decreases your retirement contributions– you need to take care of yourself in the future too).

How do you contribute more?  The first way is easy:  if you haven’t been maxing out your 401K/403B ($19500 in 2020), then up that to the amount that you used to be matched.  So if your uni gave you 5K if you put in 3K, then up your contribution to 8K (or as close as you can get).  If you had a 100% contribution, then double what you’re currently putting in.  If you put in 10K and your company put in 5K, then contribute another 5K.  (And if the match comes back, you can still contribute the full 15K– your company is allowed to contribute something like $37,500 on top of your own contributions.)

If you’re already putting in $19,500 each year and have lost the match the first place to look to put in more money is into an IRA, up to $6,000 additional.  If you’re able to put in $19,500 to a 401K/403b plan, chances are you are only able to contribute to a backdoor converted Roth IRA because you’re making a lot of money.  But if you do make less than the income limits , you can contribute to a regular IRA Roth or Traditional IRA without having do a backdoor conversion.

If you have already maxed out your IRA space, check to see if your company allows Backdoor Roths with their 401K (these are less likely with 403b, since they are a way for high income people to hide said income from taxes, but who knows, maybe the fed has them).  If so, you can contribute up to $37,500 tax advantaged in one.

If you don’t have any of these options but you want to protect your future self, think about other places that you can put the money you are losing out from losing the match.  Do you have debt (including mortgage) you could pay down?  Do you have a high deductible health insurance plan with a health savings account?– That money is tax advantaged twice!   If you are planning on paying for your kids’ college– maybe the 529 could use a boost?

The truth is, if you are getting your retirement match cut, you are getting a pay-cut and you need to adjust your spending/savings if you can.  If you are in a precarious situation, then you need more money in short term savings even if it means a spending cut.  If your situation is more stable, then you need to make up for the future loss from lost retirement savings, preferably in a way that is tax-advantaged.

Have your benefits been cut this year?  If so, what are you planning on doing as a response?

Ask the grumpies: Can I Retire Early?

Middle class revolution asks

By the time you post this, I may already be out of a job. However, i can always use your money wisdom and that of your readers. I may also ask Frugalwoods but they want so many details.

Here is some background info about me and my family:

– Family = me (50), my husband (poor health), 2 young kids – one with special health issues and low functioning autism. We don’t plan to pay for college but want to support spec needs kid with a trust (from home sale?).
– My parents live nearby and currently offer babysitting help.
– We own a single family home in a high cost west coast state. It is safe, blue collar, ethnic neighborhood with so-so schools. Valued at $500,000 to 600,000. We are 2 years away from paying off mortgage. May do this sooner if possible.
–  I have a 401k, rollover IRA, Roth IRA totaling . My husband has no retirement savings. Total value of approx. $470,000 depending on stock market.
– I will get social security but don’t know amount.
– Husband earns approx $5k per month from state as our kid’s caregiver. I will take over this role. He can get health insurance thru this job but I don’t know how good it is.
– My income was $3k per month after taxes, 401k contributions and health care premiums.
– Currently spend about $4k per month. Want to reduce this.
– We own 2 cars and will sell one.
– We have no debts.
– We don’t have a will or life insurance (very bad, I know)
– Both sets of our parents are financially fine. His parents already gifted us to help buy our house. No inheritance expected.

I am resigning due to a bad work situation (horrible boss). I do not expect to find a similar job since I won’t have my boss as reference and I’m 50.

Did I make a horrible mistake? Will I end up eating cat food or worse?

Please advise!

With a low functioning disabled child, you need to get a will AND life insurance NOW.  This will probably be pricey if you’re thinking about a trust.  Along with the thinking about a trust, the law office will likely be able to recommend someone to think about the financial aspects of your plan for your child.  How much will they need after you are gone?

I always think that the FrugalWoods are overly optimistic about retiring.  I mean, I guess that’s their brand but also they haven’t lived it (since Mr. FW has never stopped working for an employer and Mrs. FW has her own business), so…

Looking at your numbers, with half your wealth locked up in your house and a low functioning child and spouse with health issues… I would not personally retire early.  If my job were terrible, I might leave that job, but I would definitely keep looking for another opportunity or get more education to switch fields or *something*.  I don’t think you have enough to safely retire because your life right now is highly dependent on the whims of a state government.  And we just can’t count on governments.

You should figure out social security amounts for you and your DH.  We used to get printouts from social security on a regular basis, but I think they’ve stopped doing that (possibly because they know the social security trust fund will be running out sooner than it should).  They have a retirement estimator on their webpage but the interface is not great.  I think you may be able to get it to do what you want by choosing “add a new estimate” after it gives you the stupid initial estimate that assumes you will work until 62/6?/70 and then telling it you want to work 0 at your current age.  I ran through it that way and if I stop working today (or age age 50), I will get about $900 less per month than if I keep working until 62, and 1900 less than if I keep working until age 67 (I’m guessing my big salary years are still replacing low income years in my work history).  Keep in mind that you will need more future dollars than you do now because of inflation.  (Low estimate:  2%, high estimate: 7%… any more than that and Social Security will have worse worries than keeping up with inflation because we’ve turned into a Banana Republic and nothing is safe.)

A big worry is that $5K/month won’t last.  That is extremely generous and it is likely that when your state hits financial difficulties in the future or gets a Conservative governor that this program will get trimmed if not cut entirely.  Even if it doesn’t get trimmed it could not keep up with inflation.  You cannot count on it as safe income.  Also, looking up the program, the amount you get depends on where you live, so it will be dangerous to tap into your house or to move someplace less expensive.

You’ll need to find out the costs of health insurance and what it doesn’t cover and what the copays are and so on and if the people your husband and child have been seeing take it.  Along with property taxes, that’s a big necessary expense.

I like this Nerd Wallet calculator.  Be sure to click on the “optional” so you can put in spending and retirement age and so on.  It’s not going to be perfect because social security will be hard to figure in there.

Yes, age discrimination exists.  Fortunately although it happens sooner for women than for men, there’s also a bump up in hiring for women at older ages, so you shouldn’t give up on finding a new job.  I don’t know if resigning your current job without a new one lined up is a mistake– if it’s affecting your health etc. sometimes just quitting is the best thing you can do.  But if you haven’t quit yet, I would like to encourage you to sweeten up your boss so you can get a good reference, explore other options within the company if possible (can you cut to part time?  are there other units within the company?), and so on.  Think strategically– knowing that you will likely quit, how can you put yourself in the best position possible for finding new work (possibly after the pandemic is over).  When you quit or get fired with cause you don’t get unemployment insurance unless the government steps in because it’s an emergency.  It might make sense to wait until the Heroes act has been passed (and call your senator to get it passed) to see if it covers unemployment for your situation.

Or you can hope to get laid off or negotiate a voluntary separation package with your company, since it’s difficult to fire people from middle-class jobs in those west coast states.  It might be worth talking to your management about this possibility.  Be strategic.  Or if they don’t actually want to lose you, they might be willing to fix some of the problems you’ve been having with your immediate boss.  Who knows!

So… bottom line, no I don’t think you can retire early in this situation.  If everything goes well, then you might be able to do it… a 60K/year income with a paid off house and health insurance might be fine even in an expensive city given savings and Social Security kicking in in 12-20 years.  But you can’t really count on the income increasing with inflation or not being cut, you can’t necessarily count on your property taxes staying put (and you need to stay where you are for the benefits), you can’t count on health insurance not bankrupting you, you can’t count on getting more than 70% of your anticipated Social Security claim, etc.  And your responsibilities (husband with health problems, low functioning child who will need lifetime help) are much too high to allow for you to cut expenses to the bone should things go wrong.

Update from Middleclassrevolution:

Family

– Me Middle Class: 50, good health, the one quitting her job ASAP.
– Husband: 60, declining health, home caregiver
– Kid 1: 10 years
– Kid 2:  9 yrs, Special health issues and low functioning autism.
– My parents: 80s, fairly good health but I am not counting on their babysitting help for much longer.

Assets (conservative estimate)

– Single family home valued at $500,000 to 600,000.
– $470,000 in various retirement accounts.
– $30k emergency fund
– Two cars (both owned 100%)

Income

– Me: $60k per year. Much of it goes toward insurance premiums and 401k contributions. Take home pay is closer to $2k per month.
– Husband: $4.5k per month income from state as caregiver. Income is not taxed.

Future Income

– Social Security: amounts unknown.
– No inheritance expected.

Liabilities

– Mortgage : We are 2 years away from paying this off but may do this sooner if possible.
– No debt
– No will, no will, no life insurance. (Bad I know!)
– Both sets of parents are financially sound and will not need our help.

Health insurance

– Three of us are covered by my employer’s high deductible plan.
– Special needs kid is covered by state programs due to health issues.

Career

– I plan to quit and take over the Caregiver role. This job does offer health insurance but I don’t know copays or premiums.
– Unlikely to find another job due to ageism and inability to get a reference from current boss

Spending

– Currently spend about $4k per month. Want to reduce this.
– We plan to sell one of the cars ASAP.

Other factors

– My husband is very impatient with special needs kid. He is good at stepping in when needed to get kid to change clothes, brush teeth, etc.. However on a daily basis, he tends to ignore him, [ed. deleted by request]. I never understood why my mom felt the need to help every other day (alternating with part time nanny). I thought my husband was capable of being sole caregiver. Now that I WFH, I am not so sure he can manage much longer.
– Without school for months and re-opening unlikely, special needs kid will continue to regress.

So… some of the numbers are different compared to when we gave our first advice and the husband [doesn’t sound as good].  If you really do need to stay at home with your child during the pandemic (a common story for many women, and not indicative of their underlying quality of workers), then maybe paint the leaving your job narrative that way and make sure that everyone else is on board with that narrative at the company because it is likely when you do try to return to the labor force (and you will likely have to) your former boss will likely be elsewhere and somebody else at the company will be providing a reference for you.  Hopefully your DH has some redeeming qualities or will be bringing home Social Security in a couple of years, [ed. deleted].  Though since he is close to 62, if he has Social Security benefits, it is unlikely that those will drop (though they may not keep up with inflation) and you may be able to transition to retirement with them, so figure out what they are.  He’s got to be useful for something once he’s no longer being paid to ignore your kid.

Also given your husband’s age and health, it’s probably not cost-effective to get life insurance for him, even term, so just get it for you.  But you can still look into costs.  You do need it for you.

Update:

No honestly he has good points too. He does most of the cooking and a lot around the house and yard. I am often impatient with my special needs kids too. The situation has taken a toll on us. I cannot manage both kids alone.

I realized that I changed 5k to 4.5k…I am not sure of exact amount so I lowered it. I guess that 500/mo makes a difference..

$6000/year when you’re not bringing in a lot does matter (as does knowing if your current take-home pay is 24K/year or 36K/year).  But more importantly, before you make your next move at work, you need to figure out the values of all of these numbers (including Social Security) so that you can make an informed decision.  30K in cash emergency fund does buy you some time, but will schools be reopened in 7.5 months?  It does sound very likely that you will quit this job, but before you do, get all of your ducks in a row.  It might be worthwhile getting all those numbers that the FrugalWoods want even if you don’t actually email them for advice.

Update:

I checked my husband’s monthly income and it is 5k , not 4.5k if that makes a difference.

Finally my son is already stronger than my me, my mom, and nanny. When he gets angry, he hits hard, scratches, twists our fingers and sometimes bites. It is probably when not if he will do more serious harm. Yes we are looking unto meds. Bottom line: I can’t physically manage him without my husband. I would like to keep my son home with us as long as possible.

Grumpy Nation:  Would you retire early in MCR’s situation?  What things should she be thinking about?  What questions would you ask?  Do you have any suggestions for how to best separate from a bad job when you’re in your 50s (especially a state with employer protections)?  Any other advice?

Don’t forget to increase your 401k/403b/457 withholding for 2020 (if that’s something that works with your financial situation)

The annual limit for your standard 401k/403b/457 goes from $19,000 to $19,500 from 2019 to 2020.  That means you have an additional $500 (or $1000 if you’re working for a state institution that has both 403b and 457) that you can put away for retirement in a tax-advantaged fashion.

I went on the awful university internal site and figured out how to futz with my 403b withholding (it took about 20 min and a ton of googling to figure out– this is still better than the paper way we had to do it before which always took at least an hour, including finding the forms and the addresses the forms needed to be sent to), from 2111.11 to 2166.66 given my 9 month salary.  Then I went to the easy and painless 457 site and futzed with that withholding (5 min, most of that digging out my password).  Then we determined that DH had to email their admin person in order to futz with his 401k, so he did that (20 min, mostly determining he couldn’t do it himself online).

So now we have an additional $1,500 going towards tax-advantaged accounts for 2020!

When was the last time you changed your retirement contributions?

Ask the grumpies: How much to save for different long-term priorities

Ali asks:

How much to save for college vs retirement vs other savings, etc.  Basically, tell me what to do.

The vast majority of our readers should max out their retirement savings prior to saving for kids’ college.  The reason for this is that you can get loans for college, but you can’t get loans for retirement AND US colleges don’t include retirement savings in their financial aid calculations.   That means every dollar that you hide in retirement is a dollar the universities don’t take into account for their financial aid calculations.  If worse comes to worse (ex. student loan rates are high), you can contribute less to retirement while the kids are in college (because you already have so much saved up) and cashflow some of those college expenses with what you would have contributed to retirement.

Disclaimer:  This is not what we did.  Originally I paid a lot of attention to the “recommended” savings percentages in various books and made sure we were putting away 20% of our income for retirement (recommended is 10-20%, we were on the “went to graduate school and need to save extra to make up for low savings years” track).  Then some extra money went into 529s (tax advantaged college saving) for our kids and then the stock market went crazy in a bad way (remember 2008?) and we started prepaying our mortgage as well.  It wasn’t until later that we started contributing to a 457 plan, even though that would have made more sense than contributing to the 529s.

The following assumes you have no debt other than a low interest mortgage.

  1. Save an emergency fund that will get you through a missing paycheck or late reimbursement or small emergency.
  2. Put money into retirement up to any employer match.
  3. Save an emergency fund that will get you through a reasonable job loss or other large expense.  (A Roth IRA is a good place to stash this when you’re just starting out since you can tap the principal without penalty and it can go to retirement if you don’t have a major emergency.)
  4. Save 10-20% of your gross income for retirement (or the max if are a high earner).  Play with retirement calculators to get more specific on the percent.
  5. Start putting money away in a 529 plan based on how much you’re planning to contribute and what schools your kid is considering.  We have more details here, and also more generally with other 529 posts.  The short is you’ll want to play with some college savings calculators AND the financial aid calculators at individual schools that you’re looking at.  (You might want to pay down your house at this step instead because colleges don’t use most housing wealth in their calculations for financial aid, but play with those different assumptions with the calculators.)

I DO think it is important to have a 529 for relatives to put monetary gifts in if you have relatives who are likely to think that’s a good idea, and don’t just have one for the oldest boy even though the money is fungible across kids.  That’s not how gifts work– people want to give to both kids, not just one.

So… I guess that’s the basic advice.  There are exceptions to the above– people who have access to a backdoor 401k at work but don’t have high incomes might never be able to max out their retirement, for example.

Grumpy Nation:  What advice would you give?  How do you decide how much to save where?

Ask the Grumpies: Is there any reason not to put money in a Roth IRA if you can pull out the principal at any time?

Beth asks:

Short version of this question: if I have some money saved that I don’t expect to use in the next year or so, and I don’t have any non-mortgage debt to pay off – is there any reason NOT to put that savings into a Roth account?

Longer version:
I feel I am in okay shape in terms of retirement savings (far better than most Americans, not doing as well as the FIRE community), with 10-20 more years to go (preferably 10 years from now, depending on the market & health care). Because I”m in okay shape and max out my 401(k), I haven’t been saving in a Roth. Instead I’ve been focusing on paying down my mortgage (still about 10 years out) and enjoying my life in the moment.

I have been putting aside money in hopes of self-funding a sabbatical at some point. My vision is I’d arrange a leave of absence for up to 3 months; I’m not at all sure my employer will go for it so it’s all quite hypothetical. I’m too conservative/aware of age bias to quit my job without another lined up and I would really really like a chunk of time off. Words cannot express how I envy friends who work in academia and get summers off! (future post? brainstorming jobs that get summers off but don’t require being a teacher?)

I realized that I could set the hypothetical-sabbatical money aside into a Roth account, and pull out the contribution to use if I DO have a sabbatical, and if I don’t, then I’m that much closer to being in even-better retirement shape.

Is there any reason to NOT put my savings into a Roth? My usual tendency is to go VTSAX but I might be more conservative with this money since I would like to use it in the shorter term. Or, by putting it into a Roth, am I going to mentally classify it as untouchable?

I’ve got other money sitting in an emergency fund (combo of money market and VTSAX) and am now wondering why I haven’t put it in a Roth all along. Please advise!

 

If you qualify to do a regular Roth IRA without having to convert from a traditional IRA, the only reason not to would be having to deal with figuring out how to take out the principal and any other paperwork costs. For that reason it’s good to have some cash in an emergency fund (the money market in your case) in case you need money immediately without paperwork hassle (because short-term emergencies often come with mental and emotional angst and the last thing you need is a month delay because of some sort of paperwork snafu). So… I guess laziness is the main reason not to? If you’re planning on using Vanguard I doubt it will be that difficult to get your principal out (some other providers make taking any money out more of a hassle).

You can put money in VTSAX within the Roth! Though yes, within the shorter term you might want to stick it in a bond fund or something similar. The heuristic is generally to put money you think you’ll need in more than 5 years into stocks and to be more conservative with money you’ll need sooner.

If you can only do Roth IRAs through a traditional conversion (a Backdoor Roth) because you’re too high income to contribute to a Roth directly, you have to wait 5 years to access the Roth funds, at least according to this random website I found. So if you need the principal sooner than that, you might want to avoid doing a Backdoor Roth and instead save the money as taxable.

Here are some reasons you could withdraw distributions (not just principal) from a Roth without penalty.  (They include things like disability, first time house purchases, educational expenses, etc.)

Grumpy Nation, is there anything I haven’t thought of?  Have you ever withdrawn the principal from a Roth IRA before age 59.5?

Ask the grumpies: Getting started with money

Mel asks:

What books do you recommend for someone who is looking to understand the basics of investing for retirement and how much money a person should hold in their savings account for emergencies? Or to that end, also understanding which comes first: having savings you can reach for at a moment’s notice or putting money into a retirement plan? I’m looking for that sort of information in a book form.

I have a fairly (I think?) healthy relationship with money, carry no debt beyond the mortgage, and feel the word that best describes me is “careful.” So I don’t really need to understand budgeting or how to pay off debt, but I do want to make sure that we’ve saved enough for retirement, saved enough for college (and aren’t going to be locked out of applying for certain loans because we have too much in a savings account vs. moved over into a retirement account — is that even a thing?), and saved enough for emergencies.

I’m looking for big picture books to understand how the various plans work as well as books to avoid because they contain terrible advice.

A good primer on all things personal finance is JD Roth’s book, Your Money:  The Missing Manual.  The numbers will be out of date (you can now save $19K annually in a 401k and 6K annually in an IRA), and we now know that you can legally do a Backdoor Roth, but it is really good at explaining the basics.  Like the difference between an investment (ex. a specific stock fund) and the bucket you save an investment in (ex. a 401k).  It also summarizes many of the best ideas from the best personal finance books.

How much a person should hold in their savings account for emergencies isn’t something there’s 100% agreement on.  In general, most people agree that you should have at minimum around 1K (give or take, probably more given inflation) to cover small emergencies.  After that people tend to think in terms of months of expenses– you need 1 month of regular expenses in case your work has a billing mistake.  You need 3 months of expenses to cover things like car problems or a short-layoff.  You need 6 months of expenses to cover a lengthier spell of unemployment.  Some people will argue a year of expenses, but that’s a luxury.  Other factors are also important like how stable your industry is– if there’s more uncertainty, you need a larger emergency fund, if you are hard to fire then you need a smaller emergency fund.  If you have dual incomes and a spouse can increase hours or cover expenses you might need less.  If you own rental properties you might need more to cover tenant absences or large repairs.  Some people will keep part of their emergency fund in something safe like savings, but keep the bulk of it in an investment that could be tapped in an emergency without penalty, for example the contribution part of an IRA Roth or taxable accounts (or a 457 plan for government employees).  All Your Worth by Elizabeth Warren (yes, that Elizabeth Warren) and Amelia Warren Tyagi does an excellent job helping you think through what your monthly expenses are and how emergencies might affect them.

All Your Worth also does a great job in providing heuristics about how much you really can afford to spend given your income.  It provides great guidelines for what percent to put in required spending vs. optional spending vs. savings to provide stability in when there are emergencies.  It’s a really great read and a smart book.  As a note– one thing people often get wrong about her balanced money formula is that they think that they *must* spend what she says to spend and save only what she says to save, which isn’t true– if you read carefully, the spending amount is an upper bound and the savings amount is a lower bound.  She does note that if you are unhappy with your spending and you are saving the recommended amount then you can loosen up, but you don’t have to, especially if you’re considering early retirement.

Once you understand these big picture ideas, you can do one of two things.  You can read the Bogleheads Guide to Investing, or you can just figure out the cheapest target-date fund that your savings provider provides (ex. my work provides Fidelity so I use that for my 403b, outside of work the cheapest is usually Vanguard which I use for my backdoor Roth and taxable investments).  With the target date fund you can just pick a single date (when you plan to retire) and set and forget and it will take care of all the rebalancing and diversification and so on for you.  Easy peasy AND it matches the market, unlike the majority of active managers (who get out-performed by the market).

Here’s a couple of advanced posts on diversification of your overall personal portfolio (not just your retirement investments).  Here’s an ordering strategy of how you could choose to use your money.

In terms of college savings and financial aid, you definitely want to read this series of posts from Forbes Magazine.  Here’s one of our many posts discussing retirement vs college savings.  The short version is that depending on what schools your kids are considering and how much money you make (say, under 300K/year) then you are likely to want to shove as much money into retirement vehicles as possible.  (If I had to go back, I’d funnel some of our 529 money into 403b and 457 accounts, but I didn’t know we’d be as high income as we are now and I didn’t know that financial aid at fancy schools went so high up the income distribution.)

In email conversation you also mentioned that as a freelancer you wanted to know more about ways for self-employed people to save for retirement.  If anybody has book recommendations, that would be great.  I found a couple useful web articles on the topic.   You also mentioned you’d be interested in finding out more about how to tap into retirement money without penalty before age 59.5.  For that there’s something called substantially equal payments that you can use in some cases.  You can also always take money out with the 10% penalty.  Or take the principal out of a Roth (or 457 if you leave that employer).

In terms of what books to avoid:  Dave Ramsey is awesome for debt payment, but he is absolute garbage for investing.  Do not follow his advice for investing.

Grumpy Nation– What books do you and don’t you recommend for Mel?  Any web resources?  How should she get started?  Any advice specific to freelancers?

Ask the grumpies: How do you approach diversification?

Ali asks:

We are good savers but I fear not great investors (i.e., I have a good bit just sitting in the bank now because I don’t know what to do). How do you approach diversification?

Disclaimer:  We are not professional anything except academics.  Consult with a fee-only financial planner with fiduciary responsibility and/or do your own research prior to making major decisions about your money.

If you don’t know what to do and your money is just sitting in savings, the easiest thing to do is to pick out a retirement date (or house purchase date or whatever) and buy some of Vanguard’s target date fund for that year.  It will take care of diversification for you both right now and over time and you’re done.  (You can also mimic it on your own by purchasing the major indices in it.  Mimicking it will save you some money early on (far from the target date) when there’s not much movement because you’re not actually doing much rebalancing early on– you’re mostly in stocks.  It is still better just to buy the target date than to leave it in the bank trying to figure out how to mimic.)

Here’s #1’s original post about how she decided on percents in her retirement account.  They’re probably a bit conservative (too bond-heavy) for when she was younger, but are more appropriate now.  But #1 wasn’t trying to optimize– diversification isn’t about optimization, it’s about getting decent returns while still staying safe.  In fact,  diversification will always return lower than some subset of undiversified portfolios (it will do better than another subset though!).

Let’s step back a little bit an think about why we diversify.

Diversification is all about moderating risks.  We put some money in stocks, which are high risk/high return and some money in bonds which are lower risk/lower return because bonds keep their value in downturns while stocks are likely to lose value (but stocks shoot up high in up-turns while bonds… keep their value).  We keep some money in cash in the bank because it keeps its value and can be drawn on quickly in an emergency.  In general, we want money that we will draw on decades from now to be in stocks and money we will draw on within the next 5 years in something more accessible like cash or bonds.  The closer you get to your target date, be it retirement or buying a house or starting college payments, the more safe and accessible you want your money to be (with some disclaimers for college savings as where those are put can affect financial aid).

More advanced asset allocation will have you thinking about blue chips vs. tech stocks or emerging markets and international markets.  But the thing is, if you’re at the point where you’re not sure what to do with your money, you can just ignore these.  International stock indices tend to have higher fees.  If you get a broad-based index fund it will already include blue chips and tech stocks.  If you get a target-date fund, it will most likely include emerging markets and international markets in addition to bonds.

Diversification can also hide money from creditors like colleges or debt collectors.  Your primary residence has certain safety threshholds depending on where you live, but it can also be taken away if you use it to secure debt (as with a mortgage).  Your retirement savings is often protected.  Trusts and companies are other ways of protecting assets.

So… I recommend some thought exercises.

1.  Do you have an emergency fund that can cover reasonable emergencies (ex. water heater explosions, a delayed reimbursement, etc.) until your next paycheck?  That should be your first priority.

2.  Are you investing up to the match in your employment retirement account?  If you have low-fee options, put it in a target-date fund.  If you don’t, then compare the fees for the different index funds and pick a broad-based fund (if all things are equal, try to get one that matches the total market or the Russell 5000, but if the cheapest fund is the S&P 500 get that, and it’ll be ok).  For additional retirement savings it’s all about your employer fees and whether you qualify for an IRA and if you want to do a backdoor IRA.

3.  What are you doing about housing?  How much of your house is your net worth?  Do you want to buy a house in the future?  If you already own a house, how accessible is the money in case of an emergency (ex. having to move and the house not selling right away)?  For many people, the house is their main form of retirement saving besides Social Security, but in terms of diversification, this is not a great idea.  On average real estate goes up at the rate of the markets, but that’s the average– owning a single home doesn’t give you the average (it is the opposite of diversification).  If your housing market drops, you could lose a lot of savings (of course, it can go the other direction as well– we have friends in California who bought in 2008 and have gained a million dollars on paper since then).  So try not to invest so much in a house that having the market crash could devastate you.  Note though that whether or not you think it is ok to foreclose should also guide how much you’re willing to have in housing mortgage debt vs. equity (vs. renting).  In general, we do not recommend home-ownership unless you can put 20% down– yes lots of people manage ok putting less down, but lots of people were also put in bad situations having to short-sell or foreclose during the last housing crisis.  Basically, think about the worse case scenario and what would happen.

4.  When do you need the money that’s sitting in your bank account wanting to be invested?  If it’s less than 5 years, you can leave it there, or put it in cd ladders.  If it’s more than that, think about your time horizon–   are you investing for college?  Use a 529 (put it in one of their target-date funds).  Are you investing for retirement?  Use a target-date fund (or read some bogleheads forum about people in your situation).  Are you planning on buying a house in 8 years? Put it in a taxable mixture of stocks and bonds (what mix?  depends on how flexible your plans are given the vagaries of the market– to be honest, we just put it in the S&P 500 and cds as we got closer.)

Always do a mental run about what you expect on average to happen and what will happen in a reasonable worst case scenario (ex. 2008 stock market drop plus job loss, keeping in mind that the stock market increased before the drop, so it’s not like it’s 40% off what you put in, but 40% off what you put in plus your gains– the longer you’ve had it in the market, the more money you still have even after the drop).

Because a lot of diversification is about avoiding the low lows even if you miss out on the high highs.

And about acknowledging that long-run risk is different than short-run risk.  In the long-run, stocks will go up more than bonds or savings.  In the short-run, stocks are risky.

Satisficing will get you pretty close to optimizing risk vs. return.  A Vanguard target date fund is probably good enough, and it’s definitely better for long-term investing than just leaving money in a low interest savings account.

Here’s some next stage financial advice. Resources for asset allocation.

Grumpy Nation, how do you approach diversification?