Ask the grumpies: What do you think of the 4% rule

First Gen American asks:

Once you’ve hit your magic 4% rule retirement number, should you reallocate to a more conservative asset allocation. Why or why not. And what do you think of the 4% rule.

Standard disclaimer:  We are not financial professionals.  Do your own research and/or consult a fee-only certified financial planner before making important life changing decisions. 

I mean, do you have a bequest motive?  Do you plan to make a LOT more money before you retire?

4% rule

The 4% rule is ok in terms of preserving your capital until you die on average.  But it’s bad in terms of volatility and uncertainty.  You don’t know how your monetary needs are going to change over time, so it might be too risky.  It may also end up with you not actually being able to take out enough for your needs during a recession, and if you end up taking out more then you’ve broken the rule entirely.  I think the 4% rule is best if you have an additional emergency fund or have the ability to earn more money if necessary.  I don’t think there is any actual safe rule that will both preserve your capital as needed and ensure that you have enough money for your spending in uncertain times.  The 4% rule doesn’t get rid of the need for lots of money.  So, I probably wouldn’t retire just because the 4% rule says I can, especially not while still youngish and during uncertain times.

If you’re planning on continuing to work, it doesn’t matter that you’ve hit the 4% rule retirement number.  What matters is when you actually retire and stop bringing in new money.  While new money is flowing in, you don’t need as much in terms of conservative assets because your income moderates short-term risk, allowing you to reap the benefits of risky assets that aren’t actually that risky over the long-term.

100% safe vs. 100% stocks

Suze Orman famously keeps almost all her money in safe assets.  She recommends you play the stock market, but she doesn’t herself.  Some wealthy people only keep a little spending money in liquid assets and the rest are all in stocks and other risky assets. When you have a LOT of money, both of these are completely logical because you can live off money that’s eroded by inflation but you will also still be fine if the market drops 40% or more.

The standard calculus changes when you have waaaay more money than you will ever need.  You have to think about what it is you want to optimize.

If you don’t care what happens when you die, you’re probably fine no matter what you do.  If you want to keep things for your heirs, then you will need to think about tax optimization and definitely keep a lot in stocks– your horizon is even longer and your heirs benefit from step-up basis upon your death.


This year I put IRA Roth money into REITs

We did backdoor ROTHs again this year since that’s a good thing for high income people to do to save for the future.

With how the stock market has done compared to our local housing market, our house is no longer as big a part of our portfolio as it used to be, and since we’re high enough savings that it makes sense to diversify by branching out into things that most people need never invest in (see:  Munis), I thought it might be time to put some money into a real estate investment trust.

I read this article about why to put REITs into a Roth vehicle and thought it made a lot of sense.  Just like you would want to buy Munis outside of any tax sheltered fund because they’re already tax sheltered, you get a benefit from putting an REIT into a Roth because so much of the earnings of an REIT come in the form of dividends which are taxed at ordinary income.  Unless, of course, you put them in a Roth where those earnings accumulate tax free.

I’m not 100% sure that we really ought to have 12K in an REIT (our house is still a reasonable chunk of our portfolio, just not as large a chunk as it used to be), but I thought this would be a nice way to dip into the waters of extended diversification.  Especially since I already tried out munis which is a different kind of diversification.

I picked VGSLX which has an expense ratio of .12, which is much higher than say, an S&P or total market fund, but isn’t so bad for one of these specialized products.

Note:  Don’t be an idiot like I was this year and buy stocks in the traditional IRA before converting to the backdoor Roth.  Stick the money in whatever their cash fund is and do the converting FIRST before choosing an investment or it may take another week before you’re allowed to convert.  Update:  Though maybe not so much of an idiot since it lost money during that week, which I think means we get to take a small tax deduction, though I’m not 100% sure.  Worth the hassle?  Probably not.

401k/403b/457 contribution limits increase in 2022

The new contribution limit is $20,500.  Catch-up for those age 50 and over is still $6,500.

IRA contribution limits remain at $6,000.  Catch-up for those age 50 and over is still $1,000.

I increased my contributions for 2022!  DH can’t do his until Jan 1 though….

Ask the grumpies: Fees vs returns

Julia asks:

How do you weigh the expense ratio for a fund vs their avg returns? I tend to go for lowest fee ETFs. My husband keeps suggesting that if a fund has overall higher returns that it is worth the slightly huger fee. I’m usually looking at funds with like 0.4% or less in fees. He probably wouldn’t go over 1% but still higher than me. Is the math as simple as if the returns are higher it’s worth the fees?

Disclaimer:  We are not financial professionals.  Please do your own research and/or consult with a certified professional planner before making any life changing money decisions.

Short answer:  You’re right, he’s wrong.

Longer answer:

High fees are usually caused by active management.  Less than 50% of actively managed funds match or beat the market.  That is worse than average!  (I don’t have the cite, but the study finding that came out/got highly publicized a little over 10 years ago.)  You are better off with a fund that matches the market it is indexed to.  Yes, sometimes you will get lucky with an actively managed fund, but on average you won’t.  And, for these actively managed funds, past performance doesn’t predict future performance.  It really is just that sometimes active managers get lucky and sometimes they don’t.

Fees can also just vary arbitrarily:  Brigette Madrian did an interesting study a couple of decades ago where she took a whole bunch of S&P 500 indexes from a bunch of different companies.  These all had the same underlying index, but they had different fees for whatever reason.  These funds also had different “returns since inception” which means that the indexes that were started earlier or the indexes that got lucky and were started when the S&P 500 was at a low point *looked* like they had better returns than did younger S&P 500 indexes or those started when the market was at a high.  But the actual investment option *was the same*.  The interesting thing was that University of Chicago MBAs looked at the advertising and chose based on “returns since inception” even though such a statistic was meaningless.  Even though the funds were identical except for their fees.

Fees will also vary for other reasons I don’t completely understand but are not necessarily linked to higher performances.  Bond funds seem to have higher fees than full market stock funds.  Foreign funds, emerging markets, REIT etc.  these all tend to have higher fees than a straight up S&P 500 or Total Stock Market Index.  But even though they’re higher fee and potentially lower return, they also mitigate risk in a large portfolio.  Bonds have lower returns but also don’t move the same direction stocks do.  Other markets may have more volatile returns but they don’t completely correlate with what’s going on in your standard S&P 500.

Bottom line:  Get a cheap index, and avoid actively managed funds.  When you’re starting out, get the lowest fee Total Stock Market Index or S&P 500 Index you can get (depending on your investment options– in some company plans, the S&P 500 is the *only* affordable index fund and you have to pay a premium to get a total market fund).  If you’re lucky enough to have a cheap Target Date Fund (from Vanguard, for example), you can just set that and forget.  If you don’t have good company options, contribute to the match and then save additional money in a Vanguard IRA (traditional or Roth).

Book recommendation for your husband:  Bogleheads Guide to Investing .

Why not just do more of what you already do?

One of retireby40’s commenters asked why I don’t just do more of what I do in my free time now if I retire.  Just add 8-9 hours of that instead of working.

What do I do in my free time?  I read romance novels and surf the internet.

As delightful as both are, I do not *want* to spend another 8-9 hours/day doing that.  I would have to start reading crappy romance novels because I’d be out of the good ones and I would probably get tired of the tropes.  As for surfing the internet– the amount I do now doesn’t exactly make me *happy* as it is.

Re: romance novels, there’s something called diminishing marginal utility, which basically means that as you do more of something, the additional happiness boost you get from doing it gets smaller and smaller.  So there’s a big happiness boost from hour one of reading a romance novel, but by hour 10 you kind of want to do something else.

Re: internet surfing, I’m afraid that’s an unhealthy addiction and not really subject to rational economic theory.

So, no, I’m afraid I would actually have to come up with other stuff to do in my waking hours.  And one can only sleep so much.

What do you do in your free time now?  Would you want to add 8-9hrs/day of that if you were retired?  What else would you add?

I have no idea what I would do if I retired early

Regular readers know that I am not as happy with my job as I used to be and I really want to leave this state.  DH’s job is flexible geographically, but it’s at a start-up and could either go big or go out of business in the next couple of years and there are only 3 cities in the US where it would be fairly easy to find a new job in his specializations.

Our married and adult life we’ve followed my job.  If we changed to follow DH’s I might have to leave academia entirely and I’m not entirely sure if I would be able to or even want to make a transition to industry.  (It would be very easy to transition to government but I SO do not want to be a government policy analyst.)

We could have me do the RE part of FIRE.  DH’s job isn’t as stable as mine, but we could probably handle the time it takes to find a new position, and it would be faster to find a new position in more expensive cities.

Recently Revanche asked what I would do if I retired early.  And had I given thought to what I would do if I retired at a normal age for retirement.

Honestly, no.

I don’t want to craft.  I’m allergic to most green things, so gardening is out.  I would probably end up taking a leadership position in activism and that would make me so unhappy all the time.  I do so much more good so much less unpleasantly by getting rid of my students’ math phobia.  (And I could teach K-12 but that also sounds pretty unpleasant.  And yes, I have done volunteer tutoring before… there’s a lot of sitting around waiting for someone to show up.  Teaching Montessori sounds up my alley, but it would pay so little and I would be so sick at first.)  I don’t want to write novels.  I do like reading them.  But…

I mean, I could retire and read novels and catch up on all the movies I haven’t watched since my kids were born.  I would make elaborate dinners.  And organize things around the house.  And gradually get lonely and depressed.  I would probably set myself strict schedules to make my days go by more quickly.  I might look into fixing up my health, but also I might not.  Whether or not I got out and spent time with other not employed people would entirely depend on where we were living– I do not at all like the SAHM around here.  I picked up books at the library the other weekday when story time was starting and it was a terrifying parade without a single mask.

I could also play video games which are really engrossing but make me incredibly depressed when I stop, unfed and unwashed with bleary and dry eyes, having spent the day and much of the night playing.  (I cannot have access to video games or that is all I will do.  I don’t even take restroom breaks until I really have to.)

I would probably try training service puppies.  I have the kind of forceful personality that dogs tend to respect.  And I LOVE puppies.  Dogs, not so much.  I mean, if it were my own dog, that would be different, but I’m really a cat person at heart.  So I do think I could train puppies and then give them back.  I mean, I trained my sister’s dog and then left.  Fostering kittens sounds like a lot of heartbreak (longtime readers may remember when #2 fostered).

But yeah, I would probably end up finding a cause and try to fix it and be unhappy and stressed.  That’s what I DO when I have too much time on my hands.  Having a career is a way of keeping me safe from that.  Also keeps me from being too controlling over my kids.

In terms of what about normal retirement?  I have not actually thought about it because it depends on so much.  Do my kids have kids?  How is our health? How much money do we have?  Are we both still alive?  So many things can change and it’s decades from now so, no haven’t done planning.

So… I think even if things are terrible I’m unlikely to quit my *career* if I can help it, though I might quit my job.  I’m hoping to have something lined up, preferably in one of those three aforementioned cities.  I’ve been thinking that a SLAC might be nice, so long as the teaching load isn’t too onerous.  (I don’t want to go above 2/2.)  I don’t know.

What would you do if retired early or on time (but were not super wealthy, like if you’re partnered your partner still had to work)?

I am not ok

I have not dreaded a school year starting this much since grad school.  Or maybe even middle school.

My state government wants to kill my family and me and everyone else too in some kind of political power move.  It is unpleasant knowing that super villains are both real and in charge.  And most of the parents I know are too burned out to fight anymore.  (The irritating “liberal” White Doods, though, are still happy to tell us that everything is pointless and also anything we do is wrong.)

Last year’s thing with the associate dean really killed my desire to get up in front of a required core class, especially one where I have all the people who signed up late because it’s an 8am class and the later sections are full.  The previous year’s cheating scandal also still lingers.  And the year before the insane and potentially dangerous student who started threatening me because on the first day of class I asked him to move up a few rows (and my chair just sat there after forcing a meeting with him and listened to him accuse me of things until I left)– he did get moved to the online version of the class and went on to threaten other female faculty members and students in his other classes… nothing was done about him.

I don’t want to go into the office, and one of the reasons is because the anti-masker pro-gun faculty member who encouraged last year’s student to go to the associate dean now has an office directly next to mine.  And of course he goes in every day.  I assume he’s gotten vaccinated, but if he keeps up what he’s been doing (meeting with crazy right-wing students unmasked in his office and classroom) eventually he’ll probably get a breakthrough infection.  Who knows.  Maybe he’ll take horse dewormer and get super sick.  One can always hope.

I worry that I can’t protect my kids.  DC2 is homeschooling but DC1 or I could easily bring the virus home.  And probably zie would be ok.  But there’s also a chance zie wouldn’t. Or that there would be long-term consequences that affect hir entire life.  I will do a lot to protect my kids that I will not do to protect myself because they don’t have the power to make these decisions yet.

One of my colleagues quit this summer without another job lined up because he and his wife couldn’t stand living here anymore.  Last night I dreamed he got a last minute position at Delagar’s school where masks are required.

I wish I were taking this semester off as unpaid leave.  And indeed, if I get called into the associate dean’s office again this year, that’s what I’m going to do.  Take leave without pay for the rest of the semester.  The students can have the monotone adjunct for the rest of the semester while I do more job applications.

Maybe it won’t be as bad as I’m worrying.  But now that I think on it, this class has been wildly problematic for the last 3 years.  And this year I have nothing to protect me from the rabid Trump loving anti-masking anti-vaxxers like I did last year.  It’s not irrational to be dreading this semester.

But I do have an escape plan.  I can leave.  Heck, I could even quit my career at this point and Barista FI (though being an actual Barista sounds pretty awful).

Ask the grumpies: Roth IRA contribution max the gross or take-home income?

First Gen American asks:

Your child can open a Roth IRA if they have earned income. I am still unclear if the max contribution for that calendar year is equal to the gross or take home income.

According to the IRS, it is “your taxable compensation,” so that is going to be neither gross nor take-home, but taxable… it’s probably easiest to see this on the pay stubs themselves.  There should be a line on there.  (For me, it’s absent my pre-tax health insurance and other accounts, but not absent taxes!)

(Standard disclaimer:  We are not professionals, please consult with an actual professional or do your own research before making any life-changing decisions.)

Adventures in rolling over a previous employer’s 401k plan

For the first time, DH has left a company (it went out of business) and the 401K provider won’t let him keep his IRA with them.  (He still has a 403b with Fidelity at the university from when he was an assistant professor.)  All of the money is in a traditional 401K, not a Roth.

When you’re in that situation, you have four options.

  1.  Take the cash and pay a penalty
  2.  Roll the 401K into your current employer’s plan
  3.  Roll the 401K into an IRA
  4.  Roll the 401K into a self-employment retirement plan

Taking the cash and paying a penalty is a bad idea for most people, unless it is a very small amount of money and you need it. If it’s a large amount of money you probably want to keep it in retirement because if you declare bankruptcy it will be protected.  This is the kind of thing you’d want to do some serious research on before doing (as opposed to letting it just happen like #2 did once because it’s the default).

Unfortunately, DH’s current company hasn’t listened to DH’s friend and coworker yet who got DH’s last company to switch over to Fidelity (with DH’s help and my urging) so the fees on the plan are ridiculous.  We don’t want to roll over to them.  (It seems to be a very popular retirement company for start-ups– they suspect it’s super cheap for the companies and puts all the cost on the employees.)

Ideally we would roll over into an IRA.  IRAs are great because you have control and you can use any firm you want, like Vanguard!

There’s another wrinkle though– since we want to be doing Backdoor Roths every year, all that IRA money needs to be Roth money, not Traditional.  Unfortunately, DH’s 401k is all traditional (probably because the expensive original firm didn’t do Roths and then I was protesting Trump by switching everything from Roth to traditional).  So that means that on top of the IRA rollover, we also need to move everything from traditional to Roth and pay taxes on it.  If we don’t, then doing a backdoor Roth will be complicated.  Basically we would end up pre-paying some amount of the taxes owed on the traditional IRA each time we did a backdoor Roth (this is called the pro rata rule).  In theory, the taxes on the principal would come out the same in the end, but having to figure out what to pay each year sounds unpleasant.  It could also increase our tax bracket for the year and we’d eventually be paying taxes on earnings too.

How much money are we talking about?  $232,000.  That is not chump change, and from what I read, that entire amount would be added to our income for the year if we did a Roth conversion, much of that in higher tax brackets than we usually face (even with DH’s unemployment this year).

So… for a while it seemed like the best option was 2, and we would just eat the additional 0.7% fee they add on to everything until DH and his friend can convince the company to move to Fidelity.

But then DH did some more digging into that option 4– and decided it was worth trying out.

DH looked into the solo 401k, because he had self-employment income as a sole proprietor this year.

There was a concern that 401k plans that do not get contributions can become dormant, and may even be considered non-qualified by the IRS. However, according to this page:

The IRS considers a sole proprietorship once established to continue until the death of the sole proprietor. Section 401 explicitly considers an individual with earned income from self-employment in any prior year, even if there is no earned income in the intervening years, a self-employed individual eligible for a 401k. Only the termination of a business entity that is the sponsor of the 401k requires the termination of the 401k plan.

This is the difficult official language about Discontinuance of Contributions:

Consider all of a case’s relevant facts and circumstances; but generally, in a profit-sharing or stock bonus plan, consider the issue of discontinuance of contributions if the plan sponsor has failed to make substantial contributions in three out of five years.

Vanguard didn’t used to accept rollovers from other plans into their Vanguard Solo 401k, but they do now.  So we went with them.

So after all of this research to make sure that DH could create a Solo 401K and didn’t need to contribute to it every year and could rollover, the hardest part was being on hold with Vanguard waiting to talk to a representative.

Once DH got off hold, the representative answered his questions double checking that he could do a rollover and could open the 401K and didn’t need to make additional contributions or anything like that.  DH answered some basic questions like he’s the plan administrator, that I was the beneficiary rather than whoever he happens to be married to at the time of death (thanks, DH! but let’s not get divorced), and a fund to start with (he can decide on other funds later, which he will do later once it’s made).  There’s a fee per fund, but it’s waived because we have lots of money with Vanguard already.  The guy said it would take a few days to get the account (technically a plan for the company and an account for DH, the sole employee) created after DH requested the account and signed some forms online and we should get an email from Vanguard when it is ready.

After the account is done, he should be able to contact his old plan, Fidelity, to tell them that he’s rolling over to this new Vanguard account.  We’re hoping this will go smoothly and there will be no mailing of checks involved.

The Form 5500 will have to be filed annually once the plan is $250+k.

We will update if anything goes wrong!

DH notes that when you get the notice about plan termination, you may only get a month to figure out how you’re going to transfer and to get the transferring done, which is plenty of time if everything goes smoothly, but isn’t plenty of time if it doesn’t.  So don’t sleep on it!

Have you ever rolled over a previous employer’s retirement account?  What options did you pick?

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?