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windy road

It seems like retirement is such a big issue right now. I’ve helped my parents a little in choosing retirement options by helping them figure out which were best for their situation. However, there doesn’t seem to be much good information out there. It’s mostly fear and scare articles written by journalists who have little or no financial knowledge. I’ve read all too many opening lines such as “the stakes are high and the issues complex…” Oooh. Really? It might feel that way with a impending retirement, but if you take a step back, breath, and think about this for second, it’s rather simple and straight forward.

Retirement for anyone breaks down into three concerns: finances, enjoyment, and general fear. Finances is pretty obvious, you need and want $X for retirement – how else can you retire if you don’t have enough money. Enjoyment is pretty obvious, you’re entering a new part of your life that’s there precisely for your complete enjoyment – no one telling you want to do tomorrow morning, or when to wake up (besides your significant other at least). The fear involved should be obvious too, but there are many facets, most bad, but some are actually good – fear of your financial situation and having enough money, fear of finding enjoyment after a lifetime of having outside objectives define your day, and fear of the unknown such as the impact on the stock market, or whether social security will hold up, or any number of other issues.

I think the most common problem for baby boomers when thinking about retirement is the over obsession with your financial picture. As with everyone else, there’s already the basic misunderstanding of fiancial matters, but then there’s the added fear of a new financial situation – no job bringing in new money. However, this is probably the easiest part of your whole retirement because you can either educate yourself by reading books or websites, or by talking to a professional. In the end, run some numbers and do some planning. If you don’t have enough money, then maybe you don’t go into full retirement, but the bigger question is, “what is enough?” because that depends on what you want to do. What kind of enjoyment and activities do you expect to do and want to do?

The second most common problem comes at this point, “oh my. What do I actually want to do? I’ve got 10+ years of retirement that I have to plan out.” Wrong. You have 10+ years of retirement to LIVE. Planning your finances with enough flexibility for many different options is relatively easy. The key is keeping it simple. Don’t over plan, and don’t look at too many options. Make a check list of things that would be great to do in the next year, two, or three. Get an idea if that’s financial feasible. Also, most importantly of all, pick things that will have meaning to you. This might not be an easy task if you’ve never really thought about this much before.

Finding meaning is the real dilemma of retirement. Not social security, not the stock market, and not your kids’ inheritance (this doesn’t apply to you mom and dad – inheritance is numero uno for you). A life defined by your work, and now what? Work had some level of meaning, and through that meaning, you derived (hopefully) a high level of fulfillment and enjoyment. Now, you have to find that meaning from some place else, or so you think.

If work has really been a place for meaning and fulfillment, then there is no requirement to stop working. Maybe partial retirement is a better option even if you have enough money. Remember, with the workforce getting smaller as baby boomers retire, baby boomers will be in growing demand. You have a wealth of knowledge and experience that’s still valuable. Either way, partial retirement or no, the key is finding meaning, and if you aren’t finding ways to give back either to your community or elsewhere, then you might find retirement lacking.

All of this might be a little scary because it’s a part of life that’s new. Personally, I think that should be exciting. Life is uncontrollable and unpredictable, so when something new comes up there is something great in that, especially after a lifetime of semi-predictable work. The freedom in retirement is a little scary, but has a lot of potential. After 40+ years of work, when was the last time you thought about the potential in your life like when you graduated from school? Potential eventually turns into fulfillment (or not), but now that’s back again, and should be a fun thing to deal with.

Brining this to a close, you shouldn’t be overly worried about the financial situations that are outside of your control. Baby boomers are the most powerful political group out there, and if you think the government is going to let social security fall apart, then you’re forgetting how influential your generation is. Additionally, many people are worried about the stock market. With so many people moving their money around and potentially getting out of the market, what will happen your money in the market? Easy, as you and other retirees take your money out, you’re going to spend it on something. You’re not taking the money out and hiding it under your bed. Your money is going directly into another company and providing economic growth somewhere, and that is what the market thrives on. The circle of money will continue, and baby boomer retirement money will leave your hands and move into the hands of those worthy of that money. I expect the stock market to do quite well in that situation, so don’t worry about a thing you can’t actually control, but instead get started on what has meaning to you.



There is an almost ever going debate about active mutual funds versus passive index funds. However, the more time that passes the more obvious it becomes that passive index funds rule as a portfolio option for investors. This is based on decades of academic study and real world data, and one of the best resources I’ve read in a while is linked to at the bottom of this post (beware, advanced graduate level reading).

The reason for superior passive fund performance is most often supported by the belief in the Efficient Market Hypothesis (EMH). Most people intuitively don’t like this idea as EMH (from weak-form to strong-form efficiency) states that the prices of all traded assets (stocks, bonds, etc.) are at every moment accurately priced because all risks and information relating to an asset is known to all involved in the market at the same time, and therefore, it is not possible to consistently outperform the market by using that information to signal inconsistent prices where you could make excess returns.

The support of EMH by real world data doesn’t seem to dissuade people from not believing it in. The false assumption is that EMH means that there is no manager skill involved and any excess return generated from owning an actively managed fund versus a passive index fund is purely luck. On the contrary (as explained in the paper linked below), there appears to be semi-strong efficiency along with significant fund manager skill. However, the skill of the manager does not produce enough alpha (excess return explained by the manager’s skill) to overcome his fees on a long-term consistent basis.

Most people believe when buying mutual funds they can chose a manager who will provide them with excess return greater than an index fund. They believe that 1) managers have skill, and 2) you as the investor can figure out what that skill is, and therefore, you can choose the best manager. However, the only variable that’s really available to determine and compare manager skill is based on past performance and past return. So, assuming a rational market (investors rationally invest money), investors will chase the funds that perform the best either every year or year-over-year. As the thinking go, “there are always a few mutual funds that do better than index funds, so why settle for market returns when you could get above market returns by choosing an active portfolio manager?”

The flaw in this thinking isn’t that managers don’t have skill (as that’s not what EMH means), but that 1) you can choose the winning managers based on past performance, and 2) that manager’s can maintain their excess risk adjusted return as invested money moves in and out of the fund, especially as successful funds draw more money over time. As quoted from the resource below based on their study (emphasis added), “investments with active managers do not outperform passive benchmarks [index funds] as a consequence of the competitiveness of the market for capital investment. If investors compete with each other for superior returns, they end up ensuring that none exist. A consequence of this insight is that the average skill level of all active managers cannot be inferred from their overall past performance…performance is not persistent precisely because investors chase performance and make full, rational, use of information about funds’ histories in doing so.” (p2-3).

What this says is that because you decide to chase performance and invest your money with those you believe to be the best funds with the best managers, and everyone else is doing the same based on past returns, any future excess return is diminished in part because of the new flow of money in to the fund. Managers’ skills are typically limited to the amount of funds under their control, and the better managers typically manage more money, but in doing so, they charge more to produce that excess return, and the fund also grows beyond their ability to manage the fund. So, even with a skilled manager, you will not find consistent returns, but that’s still assuming you actually have a clue what it means to be a skilled manager.

There are plenty of other reasons for investing in index funds instead of mutual funds including, but not limited to simplicity of investment, reduced risk of investment, and increased return of investment for a similar mutual fund of greater risk.

Mutual Fund Flows and Performance in Rational Markets

overgrown tv

I’ve decided to write this mostly because of this post at the great I Will Teach You To Be Rich called How do you budget when you have irregular income? The sum of the post is a reader asking Ramit how he should budget with his very irregular income. Check out the post, but I won’t cover it more than I have to because you can just read the original if you like. I’ve left my own comments under the pseudonym MyNameIsMatt.

Yes, budgets are bad. Not just because we don’t like doing them, but for many of the reasons I’ve covered in previous posts in how they relate to your money mentality. Now, budgets aren’t necessarily bad, and they have helped a number of irresponsible spenders, so I can’t say everyone should swear them off. However, they’ve been tauted by the “wise ones” almost as some magic bullet that should sit on a pedestal for anyone desiring responsible personal finance. The problem with this is that it leads to the type of question asked of Ramit where the individual has no real problem. He just feels that he isn’t budgeting correctly for his irregular income. He feels out of control, and thinks that the only means of correcting this is by correcting his budgeting. This is far from the truth and actually establishes a bad habit for any responsible personal finance.

The budget is not king, and your budget has no direct relation to your income. Your expenses, and hence what you derive your budget from, is based on your lifestyle. Income provides options that support your desired lifestyle, but has no direct relation to your expenses. If you make more money, then you don’t inherently increase your expenses. If you make less money, then you may need to change your lifestyle, but that doesn’t mean you therefore budget based on your income.

If your budget is based on income you’re doing two things wrong. First, you’re succumbing to the always “need more” affluent society that corporations pressure us to live in. Living based on income means you’re limiting yourself to your current financial paradigm and not based on how you want to live your life nor how your need to live your life. The money numbers that you see now define your life instead of you defining it yourself.

The second thing that happens is the budget becomes king. When the budget is king you’re more likely driven to two extremes. Either you live at the short end of your money numbers where you live within your mean (all very good and well), but less likely to stretch out of those means. Instead of being driving by needing more (or less), you should be driven by personal growth. That is expanding yourself and not necessarily your possessions. Taking adventures and living life through all of your opportunities. However, if you can only see the opportunities that you’ve budgeted for, then you’ll invariably miss out of tons of great life experiences.

The other extreme you could go in by making the budget king is by living beyond your means. Not caring about your budget in the least because it’s just too much trouble, too painful, and therefore not worth your time. In the comment thread of Ramit’s posts two points were made obvious, and they’re right for any situation (irregular income or more regular annual income), which is that you need to know your minimum living expenses and have a small emergency buffer so that you can handle any challenges from changes in income or lifestyle. This is really the extent I think anyone should budget unless you have specific goals like buying a house or saving an extra 5%. However, when you take the view of budget is king yet too troublesome to take seriously, you begin living life beyond your means. All you see (or don’t see) are the money numbers driving your growth and life adventures (“gotta have this and that – be the rockstar”), and not the numbers that actually support that life.

Budgets are bad because they have a tendency to limit and limit not based on personal needs and wants, but probabilistic situations (“I’ll probably need $X for this and $Y for that”). For many people, they have a problem spending and saving responsibly without that kind of help. That’s OK, but that doesn’t mean every one of us has to do the same, and then that we’re irresponsible for not doing it. Life is not about control, so don’t try and control your life with a budget. When you’re facing the fear of control, whether it’s a mental manifestation or a real problem, you need to address the problem directly and not hide the issue behind a prescribed and overly glorified process (harsh I know, but true).

man and cow

So often a person has a question about how to get started, or how to deal with a particular issue, but what does a finished, solid, maintainable personal finance picture looks like? How easy is everything to setup, and then maintain? The more I repeat this on the forums, the simpler it seems (So, after you’ve read this, go out to the forums, or to a friends, and tell them what you read in your own words, and it’ll get more and more basic the more you describe and explain).

Of course, the simplicity of what I’ll describe can depend greatly on where you are financially now. Explaining to the guy who graduated college with $40k in savings, no credit card debt, no other debt, and a near six figure job (plus signing bonus) wasn’t that tough. He had way more than he needed, and wouldn’t have any hardships putting bunches away in different places for different uses (He was also slightly educated already on money and had done some of the things talked about in the forum, so don’t think just because he had lots of money he had a clue what he was doing – he was a smart guy who had already prepared himself).

On the other side, there have been plenty of people who had loads of credit card debt, poor credit scores (FICO score), no savings, and relatively little earnings (although I always want to hit the person that’s earning $60k, $80k, and even $100k+, has spending/saving problems and bitches about it like it ain’t their fault – even though they know they need to fix something or they wouldn’t be asking for help). Their situation didn’t change what was advised, but it wasn’t so easy getting to the end point because they had created plenty of financial hurdles to overcome for themselves.

With no further ado, the finished financial picture – in order of importance (this can change slightly from situation to situation, but will generally suit anyone’s needs):

1 emergency savings account setup in a high interest rate savings account (ING, HSBC, Emirates are names that go around a lot for these). Roughly an amount equal to 3-4 months worth of your basic living costs, rent, car payment, cell payment, food costs, etc.

1 regular checking account with a credit card and debit card attached to the account. Drop your weekly, bi-weekly, monthly whatever, paychecks into here, then filter/wire out to your other accounts (now adays all of these money transfers can be handle very easily using your banks website or the website of your other financial companies)

1 Roth IRA account (Vanguard is my favorite, but I’ve heard decent comments about Fidelity nearly as often). Maxed out yearly to the $4k limit (this limit will go up over time, next in 2008 to $5k). You’ll use this like a brokerage account by buying stocks and bonds (based on your planned asset allocation), but with tax free earnings (instead of buying individual stocks and bonds, you’ll work with index funds). For those earning big bux or growing their salary like the kid mentioned above, once you earn $95k annually, your max contribution gets cut off, so plan for this and talk to a tax agent (EA or CPA) about the implications.

1 401(k) with your current company. Usually you’re told to contribute only up to your company’s matching amount, then max out a Roth IRA. For those who don’t have matching either at this time or at all, you still want to use this retirement account for its tax benefits, but after you’ve maxed your IRA typically. This works the same as with a Roth IRA (index funds preferably if your company offers them, otherwise mutual funds) having a predetermined asset allocation to help you figure out what type of funds to buy.

1 brokerage account (Scottrade is a good name that goes around for this type of account, although companies like Vanguard, Fidelity, etc. will also have these, but with higher costs). This is your taxable retirement account. This comes last! If you can’t put money away in the other accounts first, then you don’t have the money to be doing stock trades. Still, you shouldn’t really be day trading, but buying index funds along your planned asset allocation.

That’s basically it – 5 accounts – an emergency account, a checking account, a Roth IRA, a 401(k), and a brokerage account. As your situation changes there are other types of accounts that might suit your specific needs, but generally this is what you’ll work with. Otherwise, you’ll want advice from a tax agent about more complex options like special savings accounts for your kids’ college expenses.

Maintaining these accounts is rather simple once you have your system/process setup. Generally, everything will sit still and you put money into your checking account. As you get enough money, every quarter or every month, you move that money into the appropriate account for better earnings. You should have an asset allocation plan thought out (see the side links for more help with that, especially Richard Ferri’s books) that guides what stocks/bonds/index funds you buy as your next pay check comes in. Then once a year, you’ll do something called rebalancing (also described in Richard Ferri’s books). If you aren’t there yet, it might seem like a lot, but once you have it setup, and you’re comfortable with moving your money around, it really want take much of your time at all.