How to Retire Young and Rich

A NOTE FROM THE PUBLISHER

This publication is designed to provide competent and reliable information regarding the subject matter covered. However, it is sold with the understanding that the author and publisher are not engaged in rendering legal, financial, or other professional advice. Laws and practices often vary from state to state and if legal or other expert assistance is required, the services of a professional should be sought. The author and publisher specifically disclaim any liability that is incurred from the use or application of the contents of this book.

Copyright © 1996 by MONEY magazine

All rights reserved.

Warner Books, Inc., 1271 Avenue of the Americas, New York, NY 10020

Visit our Web site at http://wamerbooks.com

A Time Warner Company

First eBooks Edition: February 1996

ISBN: 978-0-446-54969-1

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Other books in the
Money® America's Financial Advisor series:

401(k) Take Charge of Your Future

Paying for Your Child's College Education

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Acknowledgments

This book draws primarily on my seventeen years of work as a MONEY magazine writer and editor—specifically on the three MONEY guides and dozens of articles I have edited on retirement planning. For most of those projects, my "top editor" was Frank B. Merrick, assistant managing editor of MONEY magazine, to whom I owe special thanks for his knowing guidance, unerring judgment, and pitiless pencil. I also wish to thank the following experts for being valued sources for some of the information on which this book is based: Helen Dennis, for the "How Ready Are You?" retirement quiz; Peter A. Dickinson, Norman Ford, Alan Fox, John Howells, Saralee Rosenberg, David Savageau, and Robert Tillman for helping determine the 20 top places to retire; Seymour Goldberg for expertise on IRA distributions; Richard Krueger and Jane Parker for insights on retiring abroad; and Paul Westbrook for generously sharing his knowledge and thinking on all areas of retirement planning.

The Retirement Worksheet on page 38 is adapted for this book from the "How to Retire Rich" seminar system by special arrangement with the Personal Finance Network, Moss Adams, Seattle, Washington 206—223—1820.

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CHAPTER 1

Four Things You Need to Do Now

To retire young and rich. If you could see it, it would probably be a beach. If you could smell it, it would be rum, limes, and suntan lotion. If you could hear it, what else? The surf. This fantasy may be the most shopworn cliche of all—the eternal vacation. But it symbolizes one of the deepest of human yearnings—freedom. What it doesn't do is get you closer to the reality. In fact, the fantasy can turn into an opiate, unless you figure out the way to turn the dream into a well-focused goal. And to do that you will have to rearrange some of the furniture in your life. For example, you almost certainly will need to figure out a way to spend less so you can save more. Sounds like a drag, and undoubtedly it will be uncomfortable at first. But it's that old unavoidable: reality. And yes, you ought to do it soon. Now is best.

This chapter is about the handful of things that you should do as soon as possible. You have to understand that these are not your odd assortment of on-the-fridge don't-forget-to-do's, the kind of directions that no normal, busy, happily flawed human ever really follows—like "Clean out at least one closet every month. " They are much more important than that. In fact, they will serve as the foundation of your dream. In time they will turn your dream into a plan with a built-in safety net. So take these four strategies to heart as seriously as though you were signing a contract for life. Indeed, to work, that's what they have to be.

1. Learn to Save More Than You Ever Dreamed You Could.

Here's why this rule is the most basic of all. As stated in the introduction to this book, the savers and investors of this world are now largely on their own. Social Security and pensions together will not be enough to carry you through your longer life. You will need to open your retirement drive on a third front—your own savings.

As you will see when you figure out how much you will need to retire (covered in Chapter 4), your own savings may need to be substantial to cover a long postwork period. For instance, let's say your household income at retirement is $80,000 a year. You even wait until you're 65 to call it quits. Financial planners use a rule of thumb that people on average will need 80% of their pre-retirement income to maintain the same living standard later on. And say you estimate you will live 20 more years and that the inflation rate will average 4% a year over that time. How much will you need? A cool $1.17 million. If you figure to live 30 more years—and many planners say it's wise to make that assumption to be sure your money doesn't run out before you do—you will need $2.18 million.

That's the demand side of the picture. You will need lots of money for your long later life. Very challenging. Now let's take a look at the supply side: you. Also very challenging, because of the widespread belief among middle-class Americans that trying to save is futile. It's hard all right, but it isn't futile. Here's why:

We live in a hyperconsumer economy. More than economy, really: it's a consumer culture, bred in the bone and impossible to escape unless you quit society entirely and live alone in the desert. This culture knows not the face of self-denial. It has forgotten the concept of postponed pleasures upon which middle-class life was built. So you must accept the proposition that you are deeply affected by this culture, that you are really part of it. Then you must realize that when someone says "I just can't save a cent," that person really believes what he or she is saying. Then you must learn to resist a knee-jerk agreement and a supportive "That's right!" Instead, at least to yourself, you must substitute a skeptical "Let's look at the record."

The record is abysmal from any point of view. The United States sports one of the lowest savings rates in the world, far lower than that of many poorer countries. The low-savings mind-set starts early, when mere tots become raving consumers as they absorb hour after hour of TV commercials. By the time these consumers are in the work-force themselves, they are beaten down by the widely accepted notion that young people today cannot possibly achieve the wealth their parents amassed. For example, people in the fifties and sixties bought their homes before the great real estate inflation of the 1970s and 1980s, and many are wealthy just on the gain they have made on their houses. By contrast, people in their twenties, thirties, and forties by and large have had to buy in at inflated rates. All true. It's also true that the cost of a college education, which has raced ahead of inflation for decades, is the other big reason why today's workers are having a hard time making ends meet, much less saving for their retirement.

In short, saving is far from easy. But as previously noted, two powerful forces are at work to make the problem seem unsolvable—perception and superficial reality. The perception is the sense of powerlessness fueled by the strongest desire to consume ever known to humankind; the reality is the higher cost of everything we consume, starting with housing and education.

Yet ask any expert on credit or financial planning and you'll be told that the bottom-line reality is something quite different: Unless you are truly poor, there is always some "give" in your budget, something that can be cut far short of the bone. One frivolous image comes to mind: all the young folk who consume several $3 caffe lattes each day while complaining that they'll never be able to afford to buy a home of their own. Should they deny themselves the pleasure of good coffee? Not necessarily. It's just that today's superconsumers have holes in their jeans they don't even know are there. What they have surely never done is figure out how much those holes are costing them, how much a home would cost them, comparing the two sides of the ledger, and then making an informed decision about what really matters to them most.

So if retiring young and rich appeals to you, or even if you're more motivated by not retiring old and poor, you will have to save regularly. And the amount you'll have to save will probably be a lot more than you now save or think you can manage. You'll see how much when you get to Chapter 4. For the time being, let's follow the consensus advice of financial experts who say that from your thirties on—that is, once you get settled in your career with expectations of regular raises as well as increasing expenses—you should be aiming to save at least 10% of your pretax income. You make $50,000 a year? If you're not saving at least $5,000 of that, you're falling behind. And you know what that means: If you start saving in earnest sometime later on, you may have to hike that percentage to 20% or more to make up not only for the savings you didn't stash, but for the investment returns you didn't get along the way.

Here, then, without undue tedium or slogging are the basics on how to save regularly.

First of all, take a Saturday afternoon and sit down with your checkbook and a record of your credit-card charges for the past 12 months. Segregate all your bills by category for the last 12 months. Then tot up each category. At the end you will see how many dollars you spent over the past year on housing, utilities, eating out, travel, clothing, and so on. Unless you are an unusually astute bookkeeper, the results should surprise you—some of the results, that is. You will begin to get a sense of just where you have been overspending and, thereby, just where you will be able to cut back in order to beef up your savings.

To help you zero in on the culprit categories, here is a general estimate of the ideal range for each. There are two sets here—one for young singles in their twenties and one for couples in their forties with two incomes and two children.

	Singles couples with Two Kids
Housing	20–25%	30%
Loan payments	13–15%	13–15%
Food	10–15%	10–15%
Child care	0%	8–10%
Entertainment	7–14%	3–7%
Vacations	3–7%	3–7%
Pocket monkey	8–12%	5–8
Transportation	7–10%	7–10%
Clothing, personal care	4–8%	4–10%
Education	5–7%	5–7%
Utilities	4–7%	4–7%
Contributions	2–7%	2–5%
Saving	5–10%	10%
Insurance	1–3%	3–5%

You should also try to make your savings automatic, wherever possible. That way there won't be any of those poignant struggles with yourself over the tragedy of self-denial. If it doesn't go through your hands, you won't miss it. At least you won't miss it the way you would if you had to part with it painfully every month. Your first automatic savings vehicle should be your company savings plan, because of the tax savings and, often, the matching dollars tossed in by your employer. (More on that later.) Many corporations also make regular payroll deductions and put the proceeds into a bank account or mutual fund for you. Alternatively, automatic transfers can be made from your checking account each month to your mutual fund company.

You can also use the "pay yourself first" approach. Simply make sure that your retirement savings are among the first of the bills you pay each month. This may require an enormous change in the way you or your spouse think about saving. For instance, many financially sophisticated people nevertheless believe that the only way to handle their accounts is to pay down all of their debts before saving anything. As long as you have credit-card obligations outstanding, for instance, nothing goes for retirement.

This is a grievous error in thinking because it robs you of those twin dynamos that make your savings grow so amazingly—growth stocks and compound interest. For example, if you set out to save $1 million by the time you're 65, assuming an average annual return of 7%, here's how dramatically your contributions and the actual earnings of your savings would vary depending on when you begin. If you start saving at 35 and therefore have 30 years to save, you will have to put $820 a month into your account. At the end of the 30 years, your contributions will amount to $300,000; the other $700,000 will come from the investment earnings. But if you start at 60, with only five years to save, you will have to put in $13,870 a month and $840,000 of your own hard-earned, after-tax dollars; only $16,000 will come from investment return.

Another technique is to commit your next raise to savings. The easiest way to do this, of course, is to call your company payroll department and have the raise put into your employee savings plan. You can also promise yourself that any windfalls that come your way—from a tax refund to a spot bonus to an inheritance—will go into your savings.

2. Max out on Your 401 (k) or Other Tax-Deferred Retirement Plan.

If you're making headway with strategy number one, number two will be easy. That's because you will be saving enough to be able to put the maximum amount of dollars into your tax-deferred plan. If you work at a company that offers a 401 (k) plan to employees, grab it. This should be where your first savings dollars go. Only when you have put as much as possible into your 401 (k) should you go on to other ways to invest. What else not only defers taxes while your money is working, but does it on a before-tax basis?

Yet even that isn't what really makes 401 (k)s so central to getting richer younger. The twin pistons powering these savings vehicles are taxes, taxes, taxes, and compounding, compounding, compounding. Together, tax deferral and compounding make dollars multiply as nothing else can do. Here is an astounding illustration: Take a 35-year-old who earns $60,000 a year and puts 6% of his salary into a taxable investment that earns 8% a year. By age 65 he would have accumulated a total of $185,744 after paying taxes at a rate of 30%. By contrast, if he were to take that same amount of money and put it into a tax-deferred account like a 401(k) or an IRA, his pile would have grown to more than double the taxed amount—to a lofty $407,820 when he reached 65.

You can improve even on that if your employer matched your 401(k) contribution, as some 85% of them do. Typical match is 50 cents on the dollar, up to a certain percentage of salary, usually 6%. The employee can usually put in up to 10% of his or her salary, to a limit of $9,240 in 1995.

Other tax-advantaged plans that may be appropriate for you:

• IRAs. You can put as much as $2,000 of your compensation ($2,500 if one spouse is employed) into an IRA. But if you are already enrolled in a company plan, you can fully deduct your IRA contribution only if you earn less than $25,000 (for singles) or $40,000 (for married couples filing jointly). If you and your spouse are part of no company plan, you can take the full deduction. So IRAs are best for those who have no company plans.

• 403(b)s. Similar to 401(k)s, these are for employees of schools and charitable organizations.

• SEPs. These are best for self-employed people who are the sole proprietors of their business; contributions are restricted to the lesser of $22,500 or 13.04% of annual compensation.

• Keoghs. These are terrific ways for small-business owners funding plans for themselves and their employees to stash big hunks of income in tax-deferred accounts. They're complicated and sophisticated, so anyone ready to take one on may need help from an accountant.

• Annuities. These come in two varieties, variable and fixed. They're best for people who have put the maximum into other tax-deferred plans. (See Chapter 14 for more on annuities.)

3. Never Endanger Your Principal: In Other Words, Be an Investment Realist, Neither Too Risk-Prone nor Too Risk-Averse.

To retire young and rich, even if you start saving in your twenties, even if you put most of your money in growth stocks, even if you max out on your tax-favored plans at work—in short, even if you follow all the textbook do's and don'ts—you may still not accumulate enough savings in time if you aren't clear on the issue of risk. What it comes down to is simple: You will want to sensitize yourself gradually to almost instinctively taking the right amount of risk. Then your investments will grow fast, but not so fast that they burn out.

All this sounds ludicrously obvious. In theory that is true. But in practice many investors become obsessed with fear, put all their money into 5% bank CDs, and watch from behind their triple-locked doors as their returns over the years are consumed entirely by inflation.

On the other hand, many other investors are inflamed by greed, often whipped to this frenzy by even greedier stockbrokers who get them to put their money into super-risky investments that flame out and leave nothing behind. This path is far more damaging than the meek and fearful route. At least there you are left with your principal. But when you lose big, you have to win double big to make up. In fact, one of the first things investment pros learn is that if you lose 50% of your money, you have to make up 100% just to break even. Getting into that predicament makes you either give up and retreat to the safety of CDs or redouble your risk and set yourself up for a greater fall the next time.

The sensitizing process mentioned is especially delicate for people at either extreme of the risk spectrum: too timorous or too daring. As you absorb Chapter 6, "How to Invest for Your Future," you'll see this need for balancing risk take on concrete form.

4. Put a Safety Net under Your Earning Capacity.

The last foundation factor that is absolutely essential to achieving your goal is your steadily improving income. This also may seem resoundingly obvious. But in today's economy it is far from it. Hundreds of thousands of professionals and managers in their forties and fifties have been let go by downsizing companies in recent years. Their stories are by now familiar to any newspaper or magazine reader or TV news watcher. These people by and large walked out into a completely different job climate from the one that prevailed when they last were looking for work. After years of trying, many of them had to face the bitter reality that they would never again be employed at the same high rate of pay. Many had to settle for far lesser jobs. And many more entered a kind of enforced early retirement. For such people, retirement planning and saving stopped dead the day their downsizing companies let them go. Their future looks bleak as they slowly but surely run out of money.

So it is just good common sense and prudent insurance of future security for today's employees to have an escape hatch from a career that is about to be cut off. However, this is not a book about careers; dozens of other books tackle the great contemporary issue of job security. If you haven't already plotted out your escape from job death, search out one or more of these books and don't rest until you have figured out how to keep your income high and assured until you retire.

A final note: Knowing where and how you can jump if your job self-destructs is a useful exercise for after retirement, too. For many reasons both emotional and financial, more and more retirees work. With 30 or so more years to look forward to, why not? This pungent subject is discussed in Chapter 15, "How to Keep from Outliving Your Money."

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CHAPTER 2

What's the Right Age to Retire, Anyway?

This chapter is not about your finances. It is the only one in this book that isn't. Instead it's about your emotional readiness to stop working. If your immediate reaction is to skip to the next chapter, try to resist, because the issue at hand is crucial. It is, in fact, the dark underside of retirement planning that tends to slip and slither past the hard dollars- and-cents numbers of saving and investing. It is important because without taking a hard accounting of your emotions, you are apt to drift into a long retirement of misery and boredom. Thousands are doing it every day.

Let's be very specific. You're interested in early retirement or you wouldn't be reading this book in the first place. If you retire early at, say, 60, you will be looking at around 30 years of leisure. If you call it quits at 50, it's 40 golden ones. And if you do everything so right that you can knock off at 40, you will be looking down the vastness of a half century of postwork life. Money aside, it stands to reason that you can't just rock and rock and rock through three or four decades of unrelieved torpor, especially when you are apt to be starting out on that journey in excellent health and full of zip. A far cry from the condition of retirement back in 1935, when Social Security was born: you could start getting your benefits when you were 65 all right, but the average life expectancy for the American male back then was just 63.