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This Week: I’m in my late 40s with no savings… is it too late for me?
Richard from Ohio
Richard never worried much about retirement when he was younger but says that now he wishes he had. He’d like to retire at 65 and enjoy more time with his family but admits that he’s never taken the time to learn much about saving or investing. He’s worried that, because he neglected to plan for his future, he may never be able to retire. He is almost 50, and since he didn’t give his exact age, I’ll be conservative and assume that he’s 49.
Personal savings situation…
Richard has $23,000 spread between a couple of different 401ks and $8,000 in a Scottrade account. He didn’t mention any savings or emergency accounts, so I’ll set his total personal savings = $31,000.
He has been sending $100 of his paycheck to Scottrade for several years and small amounts here and there to his 401k, but never consistently. A few months ago, after he refinanced a lot of his family’s personal debt into the 1st mortgage, Richard started contributing 10% of his paycheck to his 401k every month.
His wife wants to go back to work part-time. She wants to work about 20 hours per week. Richard explained that she sacrificed a career to stay at home with the kids and never had the opportunity to develop many professional skills. He’s excited that she is going to help, but has no idea how much she might be able to earn per hour.
Richard said that he is a branch manager, and while that doesn’t tell us much, it suggests he works in the private sector… which probably means no pension is available, only 401k. He pays about $270 per month for health insurance. After taxes, insurance, and 401k contributions, Richard brings home $3,400 per month.
Richard contributes 10% to a 401k and pays $270 per month for insurance. Since he lives in Ohio, we know that his federal income tax rate is 25% and his Ohio state income tax rate is 5.2%. After all of these deductions, he brings home $3,400 per month. Based on this information, I’m going to estimate that Richard earns roughly $68,400 per year.
Richard has one car paid for and has two years remaining on a second at $425 per month. He owns a 4 bedroom, two bath house that recently appraised at $165,000. The reason the house was appraised was that they were refinancing $40,000 worth of their own credit card debt, small loans, and the kids’ student loans into their first mortgage. The children are done with school but the youngest still lives at home.
The refinance paid everything off but the car and Richard said that this is the first time he can remember not having to juggle several credit card and loan payments at the end of the month. He is ready to start saving and wants to get their spending under control, they have already chopped up the credit cards and agreed not to finance anything for a while. This is their first and only home and, after their recent refinance, they owe $95,000. The monthly mortgage payment is $790 so I’ll assume that means taxes and escrow are included in the payment.
|Total Personal Savings (Excluding Mortgage)||$31,000|
|Total Debt (excluding mortgage):||$10,200|
|Gross Annual Income||$68,400|
|Net Monthly Income (Includes 401k Cont.):||$3,970|
|Monthly Fixed payments (Mortgage & Car):||$1,215|
|Variable Expense estimate (gas, util, ins, electric, etc.):||$1,600|
|* Our Profile is an estimate that is based ONLY on the information submitted, we do not follow up with requests for additional information. The more information you provide, the better and more specific our personal finance and investing profile can be on the Millionaire Maker page.|
Richard, it is NEVER too late to start saving and investing. When I read your first line, “I have no savings”, I was expecting a mountain of debt and a negative net worth. All things considered and compared to many Americans your age, you’re actually in pretty good shape.
What to do? Set a goal…
Actually, you’ll need to set several goals. You’ll want a total savings goal, a net worth goal, and an annual retirement income goal. The third one is the most critical and you need the first two to calculate the third so these three goals are mandatory, add as many additional as you like.
Where do we start? With your current income, $68,400. When you retire, insurance will be more expensive but you won’t have a car payment or a mortgage payment (we’ll talk about that in a minute), and you’ll be paying significantly less in taxes. Given these factors, you should easily be able to sustain and even improve your lifestyle at 70% of your current income, $47,880*.
*(for simplicity’s sake, we’ll use today’s dollars, none of our calculations will be adjusted for inflation)
We need to know how much we need to save to provide $47,880 per year, but wait… don’t we have other sources of income? Yes, Social Security. Let’s talk about that before we figure out how much we need to save.
Based on your current income and age, your social security should be at least $1,655 per month (in today’s dollars) when you retire at age 65. Remember, I’m not adjusting for inflation, especially not for income because when people see a much larger number they often become “irrationally exuberant”. I also wanted to point out that, even though Richard could draw social security at age 62, he has decided to wait until 65. That’s a brilliant move Richard, it will net you an extra $300 per month!
Don’t forget that your wife wants to work part-time until you retire as well. Even if she only makes $9 per hour and works 20 hours per week, she’ll still gross $9,360 per year. If she didn’t work when she was younger, she will still wind up with $280 in monthly Social Security benefits 16 years from now.
That gives us a conservative estimate of $1,935 total in social security benefits per month. Not bad, Richard.
Back to goals…
Hmmm, where were we? We needed $47,880 of income per year or $3,990 per month. We know we can count on at least $1,935 per month from social security so we still need $2,055 per month from investments.
In retirement, we are going to assume a 5% return. Why? You will be withdrawing 5% per year for income. You don’t want to run out of money during retirement, so we want to be conservative with our return estimates. As long as your return is 5% or better, the value of your portfolio will continue to increase, even during retirement. This is an easy target return to achieve. You could buy tax-free municipal bonds that pay 5% or better if you wanted to play it really safe.
Now we have enough information to figure out how much we need to save to earn $2,055 per month assuming a 5% return. The calculation is Monthly Income X 12 months to annualize, divided by the annual return target or ($2,055 X 12) / 5% = $493,200. Richard, you need approximately $1/2 million to meet your retirement goals.
I’m sure that sounds like a lot to you right now so let’s talk about your income next. Is this doable?
No matter what anyone tells you, income is a major factor in retirement planning, especially if you’re starting late. I have great news for you in this category, Richard. At $68,400 your household income is in the top 30% of all US households, and your wife is about to add to that considerably. Income will not be a barrier to reaching your retirement goals, it’s going to depend more on your savings discipline and how successfully you invest your money.
Continue to live beneath your means…
Richard, now that you’ve refinanced your home, you have a lot of disposable income and very little debt outside of your mortgage. Let’s keep it that way, that’s an ideal situation for someone that has some catching up to do as far as savings are concerned.
Your kids are grown and all but one is finished with school and living independently. Kids are the most wonderful gift in the world but I’m sure you’ve already noticed how much more disposable income you have now that they’re grown. That’s why grandparents can afford to spoil their grandchildren.
You mentioned in your email that you had to use proceeds from your mortgage refinance to pay off credit cards and small loans. If you’re like most Americans, you probably paid the minimum and kept running up the balance on your credit cards. The small loans were likely furniture, appliance, and other home improvement projects that you decided to finance because you were offered some wonderful deal like “No payment for 12 months” or “No interest for 12 months”. The credit card companies and the companies that offered you these terms were taking advantage of your spending habits. Don’t worry, you’re not in the minority, most of us struggle with this. We have become an instant gratification society, we love to buy now and pay later and we tend to spend as much (sometimes more) than we make.
For this plan to work, Richard, you have to adhere to three rules. They are; One – Savings and mortgage first, then everything else, Two – If you can’t pay cash then you can’t afford it, and Three – Sleep on any purchase greater than $100.
These rules may sound too simple to some and overly constrictive to others, but Personal Finance really is this straightforward. There are rules to building wealth and one of the most important is to live beneath your means. I think that after you develop good habits you’ll be surprised how much junk you used to buy and how much better your quality of life when you scrutinize each spending decision through financially savvy eyes. There will be more money left over for the things you really care about like vacations, grandchildren, and charity.
Pay off the mortgage…
I’m guessing that you’ve refinanced at least twice if you still have a balance of $95,000 after living in the same house for almost 25 years. Now that you’re going to control you’re spending, you should never need to refinance again. Thanks to your recent refinance you only have a $425 car payment, a $790 mortgage and no other debts to speak of.
So what’s it going to take to get that mortgage paid off? Our optimal scenario is to pay off your 30-year mortgage over the next 16 years so that your house is paid off at the same time you retire. Since interest rates are near historic lows and you had a lot of equity when you refinanced, you are a pretty safe bet from a bank’s perspective. I’m going to guess you received a rate of about 6% on your mortgage loan.
Based on a $95,000 loan with 30 years remaining and a 6% rate, you will need to pay an extra $205 per month to pay off the loan 14 years early. I’m not going to go through this math, but if you want to play with an early-payoff mortgage calculator, MortgageLoan.com has a good one.
We said that $500,000 is your goal, so now let’s talk about what it’s going to take to get there. We’re only going to discuss the math in this section, but don’t worry, we’ll get to the investing strategy next.
Today you have $31,000, and 16 years from now when you’re 65, you want to retire with over $500,000. You must put a minimum of $700 per month into your 401k every month, no exception. Since you just started contributing $570 per month, you only need to bump the amount up by another $130. Remember, we’re talking about the minimum amount to meet your goals. I’m trying to show you that you can easily retire at 65, we’re not trying to maximize your net worth in this scenario. Feel free to contribute much more if you can do so without cramping your lifestyle!
We’re going to assume you can achieve the S&P 500 average annual return of 10% (more about this in a minute). You are starting with $31,000 in personal savings. If you contribute $700 per month and achieve a 10% return, you will have $541,085 at age 65 if you are 49 today.
That’s why I say feel free to contribute more, $700 per month is cutting it close. How close? If you get a 9% return you would earn $477,591 and slightly miss your goal. Granted, if you average a 13% return over that period, you’d wind up with $796,690 but I prefer to err on the conservative side.
However, I’m not too worried about you… why not? Because I left three huge factors out that will work in your favor.
- First, you didn’t mention a retirement matching program, but many companies have them. Retirement match means your company will match your 401k contributions dollar for dollar up to a certain amount. Typical plans range from $2,500 to $5,000. A nice perk related to these programs is that the company match dollars don’t count toward your maximum allowable 401k contribution per year.
- Second, your wife will be working and your email made it sound like the primary reason was to help you retire at 65. That would free up a lot of cash for savings each month. I didn’t include her contribution since you couldn’t say for sure how many hours she’ll wind up working or how much she may earn per hour.
- Third, based on your current income and expenses and the fact that your wife is definitely going to work, you can afford to contribute much more than the $700 minimum I suggest above. In your profile we estimated that you have $1,155 in disposable income after all expenses. $700 of that is going to 401k (only a $130 increase over what you contribute now) and $205 will go toward your mortgage. Even at your current income, this leaves $250 “extra” money per month and that amount will increase to $675 when your car is paid off, not to mention whatever additional dollars your wife adds when she starts working.
Don’t cramp your lifestyle, there’s no point to life if you can’t enjoy it, but do contribute every dollar that you can comfortably spare.
How much impact can a couple hundred extra dollars make?
A logical question, it doesn’t sound like much. Let’s look at an example.
It turns out that your company has a $2,500 401k match, which will add $208 extra dollars per month to your 401k. Your monthly savings increases from $700 to $908. Assuming the same 10% return, $908 savings per month and 16 years to invest, you will have $651,796 when you retire at 65. That’s an additional $110,711 in savings vs the $700 per month. Remember that your retirement income is 5% of your savings each year so 5% of this additional money means an extra $461 income per month.
Answer? $200 per month can have a BIG impact.
One last note on tax deferred accounts…
I don’t think you’ll exceed your maximum allowable 401k contribution, but if you do, you will need to put the rest of your annual savings in an IRA or a Roth IRA. I tend to go on and on… and on (are you still awake, Richard?). Since this post is already getting too long I don’t have room to go into detail, but you can learn all about tax-deferred accounts in our 401k, IRA & Roth IRA Guide.
Many beginners tell me that they are confused about what stock market investing strategy to choose. Oftentimes they are even confused about what strategy they are currently implementing. This happens because most people learn about investing from their friends, coworkers, family, and whatever investing related magazines, newspapers, and Internet sites they follow.
What they wind up with is a hodgepodge of random information to base their investments on rather than any cohesive strategy. The greatest danger in this is that, while most strategies work quite well on their own if implemented properly, they are usually quite disastrous when investors try to combine them together. Richard, what I’m trying to say (with far too many words), is to choose one strategy, work hard to master it, and stick with it in good markets and in bad.
There are also a lot of basic investing principles that beginners tend to ignore because they are chasing instant riches, they want every stock to be the next Microsoft or Google. You don’t have the luxury of time, Richard, you can’t afford to spend years learning these painful lessons the hard way like the rest of us did. Don’t worry, this is doable, you can learn from our mistakes.
Here are a few basic investing principles that you should always observe:
- Diversify your money and spread it out among various assets such as Stocks and Bonds. Done properly, a good asset allocation and diversification mix can decrease risk AND increase returns.
Be a dollar-cost averager. That just means to add money every paycheck regardless of how the market is performing, don’t try to time it.
- Manage your expenses. Trade infrequently to keep transaction and tax expenses down. Pay attention to things like the expense ratio of your funds, loads and other unnecessary fees, and how much you’re spending on investing advice.
- Compare to an appropriate benchmark. The S&P 500 is a nice broad benchmark but there are many others that you may want to watch depending on your portfolio. See our Major Index Reference Chart for more information.
- Don’t follow the herd, stick to your strategy and avoid chasing returns.
- Invest in what you know. it’s tempting to buy the occassional IPO or hot stock based on a tip from a friend or broker. Don’t bother, odds are not in your favor when you trust water-cooler advice. You will do best if you always stick to your strategy and continue to work hard to master it.
We can only touch on a few highlights here. If you want to learn more, The 10 Basic Principles of Investing is a great place to start. It’s a short read packed with valuable information for any beginning investor.
Choose your strategy…
Richard, this is a challenging topic to squeeze into a few short paragraphs. There are many different investing strategies, but the one I most often recommend to beginners is Index Investing. Index investors choose funds that own the stocks of whatever index they’d like to track… That’s it, that’s the whole strategy.
Don’t let that fool you into thinking it is weaker than more complex strategies, Index Investors beat most professional fund managers and analysts. Some of today’s greatest investing minds, such as Warren Buffett, recommend this strategy to the average investor that can’t commit 40 hours or more per week studying their strategy, their investments and the market.
What is index investing?
While most of us buy bits and pieces of the major indexes when we buy stocks or mutual funds, Index Investors want to own the whole thing. How can they own a piece of every stock on a broad index such as the S&P 500? The investing vehicles they use are called Index Funds and Exchange Traded Funds (ETFs), and when they buy shares in either type of investment they own a small piece of every stock or bond an index tracks.
Index Investing is the most cost efficient and tax efficient portfolio you can own since it is a buy-and-hold strategy that requires very few transactions. It is also (in my opinion at least) the easiest strategy to master.
I think that, after you study the strategy, you will wind up being a Balanced Index Investor, Richard. They are typically mid-career and feel optimistic about the market, but want to avoid extreme volatility because they would like to retire in 10 to 15 years. They are looking for capital growth but would also like to have a large chunk of their portfolio in the biggest and safest stocks that can dampen volatility and pay generous dividends. They tend to want some money in bonds for safe but modest returns and to offset the risk of their stock holdings. Sound like you? I think it does, but only you can decide.
Index Investing is a passive strategy, your portfolio will be very low maintenance. Index Investors don’t need to perform constant analysis or even stay abreast of market and economic trends, they just need to check in now and then to make sure their funds are still expense-efficient, tax-efficient, and closely tracking their indexes. They will also review their allocation and diversification mix now and then to make sure it still matches their investment goals and risk tolerance.
This is a massive subject, and one that deserves a lot more attention than I can give it in this article. If you want to learn a great deal more about Index Investing you can choose from our Index Investing Strategy Review or our Complete Guide to Index Investing. Enjoy!
You’re brain probably feels like mush right now. Richard, trust me when I tell you that any confusion you feel is a result of the overwhelming amount of new information being thrown at you, NOT because investing is overly complex or sophisticated. Keep it simple, and study whatever strategy you choose diligently and I promise that you’ll start to “get it” in no time.
If you prefer to review other strategies before deciding…
Here’s a brief list of some of the most popular strategies. Each is also a link to one of our popular strategy review guides.
– Value Investing: “I won’t buy unless the stock is selling for less than it’s worth.”
– Growth Investing: “I’m willing to take some risks for portfolio growth.”
– Income Investing: “This money has to last a long time, I’m playing it safe.”
– Mutual Fund Investing: “I want professional expertise guiding my portfolio.”
– Index Investing (Index Funds and ETFs): “I’ll let the market do the work for me.”
– Momentum Investing: “I want to own hot stocks until they cool off.”
– Market Timing: “Ride the Bull and hide from the Bear.”
– Day Trading & Technical Analysis: “I have no fear of risk, I will take big chances for big gains.”
You mentioned in your email that you feel comfortable with your current life insurance but I thought I’d pass on a good method for determining the amount you need just in case.
Many people will throw out generalizations like 5 X your annual income but these methods are dangerous. A better approach is to think about how much your family would need if something happened to you.
For example, if your family will need $40,000 per year to get by and you know that social security and investments will provide $25,000, then you know that the life insurance needs to make up the additional $15,000 income per year. Using the same 5% method we used to calculate your savings above, we divide $15,000 by 5% to get our answer, $15,000/5% = $300,000. You would need $300,000 worth of insurance to generate the $15,000 annual income. This simple calculation works for life insurance because death benefits aren’t usually taxed.
What’s the bottom line?
Richard, you’re in great shape…
Many people that read this review may worry that $47,880 won’t be enough in the future, but they’ve missed an important point. We did all of our calculations in today’s dollars, I didn’t adjust any calculations for inflation. Don’t worry, we planned for inflation even though we calculated in current dollars.
For example, your social security benefits will actually be closer to $2,924 per month when we adjust for inflation. The same applies to your total savings as well. You will get pay increases of 3-5% each year and you should be adjusting your savings up to match. I avoid adjusting for inflation because when you show beginners big numbers, they tend to get confused and overly optimistic. Doesn’t $2,924 per month social security make you feel warm and fuzzy inside? It shouldn’t, it’s equal to exactly $1,655 in today’s dollars.
I feel like we laid out a relatively conservative plan, Richard. Given your current situation, these goals are very achievable. You’re carrying little debt and you make more than enough income to support the savings and investing goals we laid out.
One last word of caution. There will inevitably be market corrections and recessions, and you will be tempted to go to cash, chase returns, or switch strategies. This type of behavior usually has disastrous results. Stick to your strategy, don’t be discouraged when you experience setbacks, the bull will always return eventually.
It’s going to come down to your desire and determination, but it sounded to me like you have plenty of both. Adhere to the rules of wealth building, work hard to master your strategy, and take good care of your body and mind.
Wow, this has been a productive morning. Sorry for the length of the article, this is much longer than I originally intended. I love giving reviews because it keeps these important topics fresh in my mind. I hope some of this information helps you, Richard. I (and I’m sure all of our readers too) wish you the best of luck! Please check back in every few months to tell us how you’re doing.
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Best of luck and please add your thoughts to this post, we’ll all benefit from your questions and insights.