Retirement planning is not overly complicated. But it does require some effort and due diligence. First of all, one needs to recognize the importance of having a plan. It’s never too early to have some goals and a plan for how to achieve them. Retirement planning requires savings on a regular basis and investing those savings wisely and relatively safely. Another important factor is the length of time those savings could grow and compound. That’s why we cannot overemphasize how important it is to start saving at an early age. It makes retirement planning so much easier. However, unfortunately, most of us don’t get that wisdom in our 20s or even in the 30s. But at the same time, it’s never too late either. Even if you are well into your 50s, you could still achieve your goals, though the path will definitely be harder and may require more sacrifices.

For the purpose of this article, let’s assume a hypothetical couple – John and Lisa, both are 50 years old right now. They have saved about $200,000 in retirement savings in addition to some equity in their house. It’s not bad at all. However, in a short 12 years from now, they will be 62. They may or may not retire at 62, but they would still like to make plans on what if they were to retire at 62 due to some forced situation. They would like to accumulate retirement assets worth $1 million or more by the time they are 62.

Why retire at 62? Why not work longer?

Frankly, 62 is just a number. Besides, so many people like to continue to work beyond 62 years of age. Sure, if you look forward to being at your job every day and have no issues with the job continuity, in most situations, it’s simply better to work longer, at least until 65, especially because eligibility for Medicare starts at 65. So, for many, who may have some health issues and do not have any other healthcare policy to fall back on, it may not be an option to retire prior to 65.

All that said, age 62 is significant in many ways. At 62, you become eligible to draw on your Social Security benefits even though your benefits are roughly 25% lower than if you were to wait until the full retirement age between 66 and 67. Moreover, once you are 59 and a half, you could withdraw money from your retirement savings vehicles like IRAs and 401Ks without any penalty. Also, if your spouse is younger and is going to keep his/her job and workplace medical benefits for a few more years, retirement at 62 could make sense. So, depending upon your retirement assets, spending needs, and your priorities in life, retiring early could make sense. But then, these are all individual decisions based on your specific situation.

There may be other good reasons to at least plan for early retirement, even if you decide not to when the time comes. The emphasis here is on retirement planning and not on actually retiring. Many folks face situations like retrenchments or forced early retirements, and they find it difficult to find suitable employment in their chosen professions. It may even be a voluntary retirement offer from your employer that’s sometimes too good to pass. There can be many other reasons that you cannot possibly visualize in advance, so it’s just a matter of good planning to prepare for any eventuality.

So, how much is good enough to retire?

Everyone’s needs are different. One size does not fit all. It depends on many factors, including your pre-retirement income, retirement location, spending habits, health situation, supplemental income like social security, pension, or part-time work income, but above all, your goals in retirement.

Until the early 2000s, there used to be a consensus among financial planners that $1 million were sufficient to have a very comfortable retirement. However, not everyone agrees with this milestone anymore. Obviously, $1 million is not the same as it used to be 20 years ago. In spite of low inflation numbers during the last 20 years, $1 million in the year 2000 would be the same as $1.45 million in 2019 due to inflation. Sure, there are always two sides to an argument. Many folks would argue that $1 million may not be enough to retire on in 2030. So, without a doubt, they would be better off to save more and keep some margin of error while setting their goals. That said, the one-million-dollar mark may not guarantee a very rich retirement, but with some prudent strategic planning, $1 million worth of savings can go a long way to fund a reasonably comfortable retirement for a couple provided we believe that the other pillars of retirement security like Social Security and Medicare will remain intact.

On the other side of the fence, there’s an argument to be made that it’s too high a target for so many folks who may have done everything right but invariably run into tough times due to corporate layoffs, constant shifts in the job market, and age discrimination in later years of life. This is why it’s so important to have an emergency reserve of one year worth of living expenses.

Start saving early and saving enough is critical, but is that enough?

Still, we believe the most important factor that determines how rich you are going to be later in life has to do with how soon you are willing to start saving and paying yourself first. In other words, start saving for retirement. However, another equally important factor is how you invest your savings. There are so many folks who save regularly but are too scared to invest or simply do not invest enough. They just can’t seem to tolerate the idea of their savings, losing any significant value. But they need to understand that sitting on large amounts of savings in cash is equally risky as it loses a tiny amount of value every day. Sure, we are not suggesting that you should not have any cash savings. In fact, we strongly suggest that everyone should keep six month’s worth of living expenses in cash or cash-like instruments.

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The table below shows how early savings can impact the quality of life in later years. We will illustrate with an example. Steve starts contributing $500 a month ($6,000 a year) at age 30 and increases it by 3% every year until 62. However, Mark waits for another ten years but starts saving the same amount as Steve at age 40. Assuming they both get an 8% annualized return, Steve would end up more than double of what Mark would accumulate. To match Steve, Mark will have to contribute double the annual amount starting from age 40 to 62.

This is how their savings at age 62 stack up assuming an 8% annualized return:

You are 50 and have saved $200,000

Let’s assume that you, as a couple, have saved $200,000 by the age 50. That’s pretty good, but is that enough? In our view, it’s not. But there’s no reason to be disheartened because you still have a lot of time on your side. But you need to realize you cannot delay the retirement planning any further. Sure, you may have other pressing needs, such as saving and paying for kid’s college tuition fees. But at this stage, retirement savings have to become priority No 1. Saving for college tuition should not be at the expense of retirement savings. Probably, the same goes for any other pressing need or desire.

Let’s bring in our hypothetical couple: John and Lisa

We will use our hypothetical couple – John and Lisa, to help with the illustration.

This is where John and Lisa stand today. Both of them are 50-years-old. Their combined annual salary is modest at $140,000. So far, they have about $200,000 in their retirement accounts. John and Lisa want to be prepared to retire at 62 if need be. So, they only have about 12 years left until retirement. Sure, they can work longer, but that may not always be their choice. To be able to retire in 12 years, John and Lisa realize they will have to make some sacrifices in their current lifestyle to be able to have a comfortable retirement later.

John and Lisa decide that going forward, they would save roughly 16% of their salary toward their 401Ks. These savings will be tax deferred and reduce their current tax liabilities. Until now, they were saving only 6% of their incomes. They are fortunate to get a good match from their employers for their 401K savings. On average, it works out to be 80% of their first 6% of the contributions. They have had no IRAs until now. They will put away $10,000 ($5,000 each) toward IRAs. Since they qualify for tax-deductible IRAs, they will use this option instead of Roth IRAs. This also will help bring down their current taxes. They also will open a college education fund for their kid and deposit $5,000 every year. However, this will be after-tax, but the qualified tuition withdrawals, including the growth, will be tax-free. Their target is to reach $1 million in retirement savings, excluding the primary home.

With the above decisions, and after accounting for the tax savings (due to pre-tax contributions), their take-home spendable monthly income will reduce by about $2,000, even though they will be saving an extra $2,415 every month.

Where to find an extra $2,000 a month?

There are several ways to find those extra $2,000. They can cut down their monthly budget to save this extra $2,000. They are going to look at several options and choose the ones that are appropriate for them. Some of the options that they are going to look at are:

  • They could cut their spending budget drastically from every expense item and save about $2,000 a month. Though quite doable, it may seem difficult to achieve at first glance, and they may have to make some lifestyle changes.
  • Alternatively, they could sell their current house and move to a smaller but newer house. This could save quite a bit of money and reduce the need to cut down on other expense items.
  • Sure, there’s a third way, though there’s no guarantee of achieving it. They may look for new opportunities at work with added responsibilities and increase their earning power. Any success here will reduce their need to cut down the expenses.

With $140,000 combined annual income, their current take-home income and the new plan would be as follows:

**This is a rough estimate for this couple based on income and two dependents, but it could vary a great deal based on the individual situation.

First Method:

Based on their monthly take-home income, they work out the new household budget to make for additional savings of $2,000 a month.

Second Method:

This method may be a bit controversial and inconvenient but would maintain their current lifestyle without pinching pennies. You will see this method is a lot better than the first one but requires some immediate but short-term headaches.

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Their house is worth about $350,000, thanks to rising home prices in recent years. However, they still have a mortgage balance of $140,000 on a 30-year term. After mortgage payout and commissions, they can get about $200,000 net. If they move a little further out in the suburbs and buy a bit smaller but a newer house, they could get one for $250,000. If all that works out, they can take only about $100,000 new mortgage on a 15-year term, put 150,000 cash down on the house, put $25,000 away as an emergency fund, and still will be left with $25,000. They could use this $25,000 toward paying off one of the cars and some credit card debt. Their new monthly mortgage would be about $725. After adding property taxes, insurance, HOA, etc., their monthly expense would be approximately $1,400.

They save about $600 a month in house payments and expenses, plus they will immediately save $400 in car-payments. Also, the house is new and smaller, so they would save about $150 a month in utilities. In addition, they will already have $25,000 for the emergency fund, so there would be no need to put an extra $300 a month. If you add all this up, they will save comfortably more than $1,500 a month.

They would still need to cut down their other budget items and save an additional $500, but that won’t require much sacrifice. But, now they are saving roughly $30,000 a year in 401Ks (including employer contribution), $10,000 a year in IRAs, $5,000 a year in 529-college plan, in addition to having $25,000 in emergency funds and lesser mortgage than before. What a difference this plan could make. But sure there are downsides to this plan.

Retirement Planning Part-II: Investing Successfully

The first very important part of retirement planning is to save enough and save early and regularly. It’s best achieved when it’s done on autopilot. Being on autopilot means your investment account always gets paid first before you get money into your checking account to spend on things that are essential and non-essentials.

The second part of retirement planning is how well you invest the money that you are saving so diligently. This is equally important, if not more. As we talked about it before, you cannot get rich simply by sitting on cash. Not only do you have to protect your cash from inflation, but you also need to compound it over time. Growth and compounding will do wonders to your investment capital over time.

John and Lisa decide to take charge of their investments and implement the following strategy:

John and Lisa’s 401K:

Instead of discussing separately, we will simply treat their 401Ks as one. Sure, in practical terms, since their accounts would be different and would have to be managed separately.

They decide on two strategies and divide their capital in 401K, something like 50:50 between the two strategies. They also could implement one strategy in John’s 401K and the second one in Lisa’s 401K. Obviously, there’s more than one path to get to the same destination.

Strategy 1:

For half of the funds in their 401K, they decide the following combination of funds. Once this has been set up, the rest would really be on auto-pilot. Every paycheck, contributions will be invested in the proportions as selected. Since this portfolio is very balanced, they hope to get a minimum growth of about 8%-9% annualized for the next 12 years.

  • 25% in S&P500 fund
  • 20% in the equal-weighted S&P500 fund
  • 15% in the Developed International fund
  • 10% in Emerging Markets fund
  • 20% in Bonds
  • 10% in Treasury funds.

Strategy 2:

John and Lisa decide to deploy the rest of the 401K money in a risk-adjusted strategy to ensure that they get most of the gains of the market, but at the same time, it will hedge the risks in case of this bull market turns into a bear market. This strategy is discussed in the later section. They hope to get at least a 10% return from this strategy. Besides a decent return, this strategy will reduce the overall volatility to a great extent.

IRAs:

Since both John and Lisa will be funding their IRAs every year to the extent of $5,000 each, they will self-manage these funds.

Lisa is a fan of DGI (Dividend Growth Investing) stocks and decides to implement a DGI Portfolio (described below).

Investment Portfolios:

DGI Portfolio for the IRAs:

This is the portfolio that Lisa will be building for their IRAs. She decides to build a portfolio of about 15-20 blue-chip stocks, which in theory she could hold for the next 10-20 years. Obviously, things will change over time, and occasionally she may have to make changes.

For this part of the portfolio, Lisa will like to select stocks that tend to do well during recessions and big corrections. The idea is that low volatility will provide an easier ride than the S&P500 and ultimately translate into long-term performance.

Stocks selected:

Automatic Data Processing (ADP), Amgen (AMGN), Bank of America (BAC), Clorox (CLX), Canadian National Railway (CNI), Fastenal (FAST), Johnson & Johnson (JNJ), Home Depot (HD), McDonald’s (MCD), Altria (MO), NextEra Energy (NEE), PepsiCo (PEP), Texas Instruments (TXN), Unilever (UL), and Verizon (VZ).

Table-3:

.

Risk-Hedged Strategy (for 401K):

Since John is implementing this strategy within his 401K, the strategy needs to be simple and implementable. Most 401K accounts offer a limited number of funds that one has to choose from. John decides to implement one such strategy, which rotates on a monthly basis.

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The strategy will be invested in one of the following three securities (or equivalent funds), which are:

  • Vanguard 500 Index Investor (VFINX)
  • Vanguard Total Intl Stock Index Inv (VGTSX)
  • Vanguard Long-Term Treasury Fund (VUSTX)

VUSTX is the hedging asset and will be used only when the other two main securities are not performing well. By deploying this strategy, since 1997, it returned an annualized return of 14.25% compared to 8.50% from the S&P 500. In the year 2008, it was up by +13% compared to -37% for the S&P 500. During the tech-bubble crash from 2000-2002, the RA (risk-adjusted) model was down only by 3.2% cumulatively, while the S&P 500 lost more than 43% during those three years. We would like to caution that back-testing results are no guarantee of similar results in the future because no two periods are going to be the same. However, the main advantage of using such a strategy would be to limit the downside and drawdowns during recessions and corrections.

Equivalent or similar ETFs that can be used for the above mutual funds:

At the end of every month, the strategy will check the performance of the three assets for the previous three months and select the best-performing asset. The portfolio will be invested in the top-performing asset for the next month. The process will be repeated every month. Below are the back-testing results since 1997 and performance comparison with the S&P 500. The model portfolio accumulated almost four times that of the S&P 500, mainly because of smaller drawdowns during the bear markets of 2001-2003 and 2008-2009.

Portfolio’s Values at 62 years:

Assumed annual growth for 401K accounts: 9.5%

Assumed annual growth for the IRAs: 10.5%

Total Savings for John & Lisa at 62 years of age:

** Includes employer’s contributions.

Conclusion:

In the above hypothetical model, John and Lisa exceeded their targets by about 40%. If they get lucky, they might exceed their target by even more. Even if we consider a more pessimistic scenario, they should still comfortably hit their target. Sure, our assumption of constant returns is not practical at all – that’s not how the stock market works. But these are the averages over a 12-year period. They would have negative returns in some of the years but would also have very high returns in some other years. So, over a long period of time, they always tend to balance out. Please note that in our model, we are not only diversifying in various stocks but are also diversifying in the form of three very different strategies. We particularly feel confident about the long-term performance of the DGI portfolio and the Rotational Portfolio using VFINX/VGTSX/VUSTX or SPY/VEA/TLT.

Most people understand the importance of a high rate of savings. But it’s also important to emphasize the time factor. A dollar saved early in life and invested to compound is worth much more than a dollar saved later in life. Growth is directly proportional to the time these investments have. Out of the final accumulated total of $1.4 million, their own contributions were less than half at $669,000, besides $750,000 from growth.

Ultimately, three factors define how much money you are going to have in retirement, namely, rate of savings, time in the market, and the average rate of investment growth. The first two are directly controlled by you, whereas the third one does depend on decisions you make but not entirely.



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Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, UNH, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, PRU, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, ARCC, AWF, CHI, DNP, EVT, FFC, GOF, HCP, HQH, HTA, IIF, JPC, JPS, JRI, KYN, MAIN, NBB, NLY, NNN, O, OHI, PCI, PDI, PFF, RFI, RNP, RQI, STAG, STK, USA, UTF, UTG, TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. Any stock portfolio or strategy presented here is only for demonstration purposes.



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