Retirement Savings 101
Can You Afford to Retire?
I'm going to start with the bad news, and I'll be blunt about it, as well. As of 2013, 90% of American households will not have enough money to last through retirement. Yes, it's that bad. 90% of American households will actually go bankrupt before we pass away to - I hope - a better world.
How did this happen? Very simply: The rich got richer and the poor got poorer. It started over 50 years ago, and we're a long way down the slippery slope now, with no way back. If you want to know where you stand in the American economy, picture yourself as a pebble in the middle of a century-long avalanche.
More important: What can we do about it? The good news is that there are solutions. I don't think we can stop the American financial avalanche. But I do think that each family can work to secure its on financial future. And the time to start is now.
So this article is in two parts: The first is the bad news: Where we stand. Part two is the good news: What we can do about it.
This Is a Big Topic
Our financial future is tied to our entire economy and society. One article alone is not big enough to tell the whole story. This is a practical article that focuses on do's and don'ts of family retirement planning. I've written two companion articles to go with it that will tell you more.
- Changing Realities: Retirement Planning in the New Economy explains how we got into this mess and what is going on.
- No Economic Recovery Coming: Welcome to the Fifth World looks at the deeper social and economic issues, and explains why things won't be getting any better in the next few centuries.
At an even deeper level, there are ecological issues that will drive greater economic troubles in the decades ahead. To learn about these, you can read Go Green: Root Causes of Climate Change and Toxic Waste Problems, one of eight hubs I've written about the Go Green movement.
Where We Stand
I am writing to citizens and residents of the United States about our collective financial situation, and how we can create our own personal financial future. I'm in the same boat you're in. I've studied the situation, and I'm working on a solution. And I want to share what I've learned.
As I have already said, 90% of our households will go bankrupt before we die. But that is not the worst news. The worst news is the underlying reason for this: Our whole financial world has changed, but almost everyone is living in denial of the current facts. Some are in denial because, understandably, it is too painful to think about. Others are in denial because they have not invested the time, or do not have the training, to look at the facts and decide for themselves. And, sadly, others are in denial because they profit from the old way of thinking.
It's like we were all in a convoy of ships. We trusted our captains. But the convoy was raided by pirates, and now we are in lifeboats in a very big ocean. The captains - the financial advisers and experts - don't know any more than we do about how to survive with what we have. We each have to figure it out for ourselves.
Here are the facts we must face:
- Almost all so-called investments are actually dangerous gambles.
- The American economy is driving all of us towards poverty.
- It's been getting worse for 40 years.
- The underlying problems are not being addressed.
- It's only going to cycle up and down, or get worse. It's not going to get better.
Let's take a look at each of these. But I'll keep it short, so we can get to the good news.
Don't Take Risks With Your Retirement
Almost All Investments are Dangerous Gambles
Many financial advisors will tell you that a diversified investment strategy can be developed for the average American family that will help towards retirement. They will also tell you that tax-deferred tools like IRAs, Roth IRAs, and 401K pension plans are helpful.
None of that has been true since the 1960s. To learn more, read Your Money or Your Life by Joe Dominguez and Vicki Robin. This work was available in audio format in the 1980s, and published as a book in 1993. Joe Dominguez used a metaphor that has been picked up by many others since: That we are living with an out-of-date map, so our efforts to reach our goals are all useless. Only, now, we've had the right map available for 20 years. But most of us are still following the wrong map.
Your Money or Your Life
Updated 2008 paperback, or Kindle eBook
The House Always Wins
Don't Risk Your Retirement on a Gamble
There are only two basic types of investment: Those with guaranteed no loss of principal, and those where the principal is at risk. Guaranteed no loss of principal means that you will get back the money you paid in, and maybe some more. Principal at risk means that you could lose everything.
Principal at Risk is Gambling
You work to make money, or maybe you receive a small inheritance. You want to increase that investment so you can have more for retirement (or maybe for your kids' education, or both). But everything out there isn't really an investment, it's a gamble. You could put your money in, and lose it all. This includes:
- Bonds (Other than US Treasury Bills)
- Municipal funds
- IRAs and Roth IRAs and 401Ks, if they are invested in stocks, bonds, and municipal funds
- A trip to Las Vegas, or any other casino
Only insured investments are safe. And we don't want that insurance to come from a bank that might go under. We want investments that are insured by the full weight of the United States government.
Anything else is a gamble, and the house always wins.
Federal Treasury Bills
Guaranteed No Loss of Principal
So, what investments offer a guarantee that you will not lose your principal, with that guarantee backed by the US government?
There are only three:
- Money in Savings Accounts and CDs insured by the FDIC. Make sure that you do not put more than $250,000 in any one bank, even in multiple accounts.
- US Treasury Bills and Savings Bonds. If you're going to get a bond, buy a US government bond.
- Prepaid Life Insurance. If you are healthy enough to qualify for life insurance, and you've saved up enough money to buy the insurance in full (or within 5 years), you can earn a high return.
The first two offer very low rates of return - around 1% to 2% these days. The third is a topic all in itself. To learn more, read Missed Fortune 101 by Douglas Andrew.
Missed Fortune 101
A Bit More on Las Vegas and Wall Street
There are dozens of other specific investments that people claim will make you wealthy: gold; forex (foreign exchange) trading; private investment opportunities; tax-free annuities, and many more.
None of them are a good idea until you have at least $1.5 million dollars socked away in insured investments for each person in your household.
Why? There are four reasons, covered in the next four short sections.
We Each Need $1.5 Million to Retire
A person who can work until he or she is 70 years old is likely to live until 90. Those twenty years, including food, shelter, personal care, and funeral expenses, cost about $75,000 per year, or a total of $1.5 million dollars. That assumes you have medical insurance, but you have to pay for it, and that there is some co-pay involved in medical care. Above basic shelter and food, most of that money goes to supportive care not covered by insurance.
We don't want to gamble money we're going to live on. So that's why we want $1.5 million per person, in the bank, before looking at any investment involving a risk of loss of principal.
No One Knows the Future
You will hear many people say that they have some investment that is a "sure thing." Some company is sure to make it big.
You will hear others say that a diversified investment strategy is secure. Just get the right mutual funds, and you'll be fine.
But neither of these is true for two very simple reasons:
- Nobody knows the future.
- In a global economy, everything is tied to everything else. There is no diversity that can protect you in a wide economic collapse.
The fact is that, in a single week at the end of 2007, tens of millions of people in retirement or close to retirement lost 30 to 40% of their savings. Many of them thought that they were in secure investments.
My father is a case in point. He had lived frugally and invested well. He was already over 80 and had some pension and social security. So he needed less savings than most. He had $600,000 in the bank in early 2007. He was set for life.
What he didn't do was move that money to a safe, guaranteed investment. So, suddenly, in early 2008, he had only $300,000.
The Lesson: If you make good money in risky investments (or any other way), move it into safe, insured investments as you enter your fifties or sixties. Don't let it get blown away when the next bubble bursts.
The irony of all this is that my dad is an excellent economist. He taught me how to do it right. But then he just went along with the herd, and trusted people who didn't care about his future.
Some investments, like hoping a particular company will grow, or a particular part of the market, like technology or foreign investment, will grow, are gambles. These are investments in businesses that, if they succeed, actually make some money and maybe even do some good in the world.
Other investments are purely like gambling. In math, these are called zero-sum games. They produce nothing. They just move money around. Zero-sum games should be avoided by anyone who wants to grow money for retirement. Zero-sum games include:
- Foreign Exchange (FOREX). I interviewed a very successful FOREX trader who said that his best clients were the ones who used FOREX to hide their gambling addiction from their wives. They played until they lost big. He made money every time they played - win or lose.
- Gold and precious commodities. There's no real value here, just a bet on changes in relative value.
- Commodities. Same idea: No real value, just a bet on future prices.
- Gambling. If you enjoy gambling, that is, throwing your money away, go to a casino!
Nobody wins long term in these games. In fact, they are not really even as good as zero-sum games. For investors, they are negative sum games, because the cost of the investment is always taken off the top. The people who sell you these investments always win - they take your money. That leads us to the next topic: The house always wins.
Tax Deferred Investments
A quick note about tax-deferred investments. The idea is simple: If you don't pay taxes when you are earning a lot, and invest the money, then you can pay taxes later, when you are retired and earning less.
It might have been a good idea back in the 1970s. But it was designed by a house that always wins. The Federal government designed a system that looks good to you when you get into it, but guarantees them more money in the long run. That is, you pay taxes later, but you pay a lot more.
If we all earned, say, $100,000 or more per year and then lived our retirements on, say, $50,000 per year, then tax-deferral would actually be good for us. But the reality is that we are earning less in our productive years now, and need more in retirement. So tax deferral doesn't pay off for us, only for the government.
The house wins again!
The House Always Wins
"The house always wins" is a saying about Las Vegas casinos - gambling houses - and how gamblers win and lose but the house always wins. But the idea can be applied much more broadly. I suggest that a "house" is any person or company with enough money and power to set up a system that other people will use, to research how to make money, and how to make sure they will make money.
Casinos are a house. In fact, the whole city of Las Vegas is a house. It's a well-designed machine that takes tourists with fat wallets in at the airport, empties their wallets, and sends them home without their money. And, all too often, it sends them home happy when they've lost!
Any zero sum game is run by a house, or a set of houses. Here are a few examples:
- Las Vegas, the casino city.
- Wall Street, the stock exchange, where the big investment firms take everyone's money and win.
- Madison Avenue, the advertising industry, where people make tons of money using applied psychology to get people to buy things that they do not need and that provide no value.
- Insurance Companies, who collect a lot of money from people every day, and then give a little back on certain special occasions.
- The Federal Government, which writes tax laws, and then collects taxes.
Even some beneficial parts of society that really add value are also houses that always win. One example is the banking industry which holds your money and gives you low interest, then loans it to you and everyone else at higher interest.
The Winning Houses in the US
Home of the New York Stock Exchange.
Home of the advertising industry
Home of the federal government, where they write the tax laws, then collect the taxes.
The city that empties your wallet and sends you home broke and happy
What We Can Do to Save for Retirement
Above, I've introduced the many ideas that once were good, or never were good, for retirement, but certainly aren't good any more.
What to Avoid
In sum: Avoid all gambles, all investment where principal is at risk.That is avoid:
- Mutual funds
- Retirement funds such as 401(k) or IRA or Roth IRA that actually are invested in any of the above.
- Zero-sum games, such as FOREX trading, gold, commodities, or futures
- Trips to Las Vegas
Dangerous Investments: A Review
What to Avoid
Risk Loss of Principal
Risk Loss of Principal
Risk Loss of Principal
Retirement Funds Using Above
Risk Loss of Principal; Likely Higher Taxes in the End
FOREX Trading, Gold, Commodities, Futures, Casino Gambling
The House Always Wins
Where to Put Your Money
Use only insured investments, such as FDIC-insured savings accounts, money market accounts, and certificate of deposit (CDs). As you get above $250,000, make sure you spread your money across multiple banks.
Don't Gamble Your Retirement Savings
Simple, Old-Fashioned, and Reliable
The Whole Retirement Plan
The whole retirement plan for the 21st Century is simple and old-fashioned.
There are six more topics to discuss:
- Live Within Your Means
- Get Out of Debt
- Stay Out of Debt
- How to Use a Credit Card Wisely, Without Debt, to Build a Great Credit Score
- When to Borrow Money
- How to Invest in Pre-Purchased Life Insurance
Live Within Your Means
Living within your means means earning more than you spend. And it is theo nly way to get out of debt:
- Earn more than you spend.
- "Neither a borrower nor a lender be," as the pompous but wise Polonius teaches in Shakespeare's Hamlet.
Let's go into this in more detail.
Find honest ways of earning more money. Develop a career that suits you. That may mean going to school beyond college, but only if you know how you're going to use it. Get a second job. Or keep your job, and start a small business on the side.
On the other hand:
- Don't do anything shady or illegal.
- Don't borrow money to get into business.
- Don't fall for a scam, and there are a lot of them out there, including some of the for-profit universities.
- Don't quit your job and start your own business. 95% - that's 19 out of 20 - new businesses fail in the first five years. Unless you're sure you'll be one in twenty, don't go there.
To spend less, it is good to make an expense budget. Learn how to by reading Jason Vickers's great article, Keep Track of Your Money!
Spend Less on the Basics
Rent or buy a small house at low cost. Use a minimum of heating and cooling. If you need a car, make it a cheap one with good gas mileage. Consider getting a scooter or electric bike, instead. Learn to cook and to enjoy your own cooking.
Spend Less on the Luxuries
Find activities - indoor and outdoor, alone and with others that that cost nothing (or very little) and are lots of fun. That's everything from sex to card games to meditation. Don't forget reading. And heck, these days with Netflix Watch Instantly and Amazon Prime, you can even watch TV for free with no commercials.
When you earn more than you spend, you gather some money each month. This is called your revenue after expenses, or net revenue. Use it to reduce debt and increase savings.
Get Out of Debt
If you are already in debt, then you will use some of the money you save to get out of debt.
Split the money coming in. Let's say that you are $1,000 in debt. It's nasty, high-interest credit card debt at 24% interest per year, or 2% per month. So each month, you have to pay $20 in interest.
Let's say you are making $250 in net revenue (income over expenses) each month.
Put $120 into a savings account.
Pay $120 down on the debt. That's $20 in interest, plus you lower the debt by $100. The next month, you only owe $900, and your interest is only $18. You're on your way out of debt.
Take $10 and have some fun. If you don't know how to have fun on $10, then stash it away, and have fun every other month on $20, or once every three months on $30.
A year later, you are out of debt. You have $1,000 in savings. And you can start to have $30 a month in fun and still save $220 per month towards retirement.
The numbers, obviously, are examples. The ideas are sound.
Stay Out of Debt
Let's talk about how to stay out of debt as much as we can, use a credit card wisely, and also when to borrow money.
How to Use a Credit Card Wisely, Without Debt, to Build a Great Credit Score
Even if you are out of debt, do get a credit card. Use it, and pay it off in full every month. Or, every once in a while, pay off all but $10, and then pay the rest off the next month. Yes, that costs you a few cents in interest. But, at the right time, it will save you thousands of dollars.
Above, I quoted Shakespeare and said, "Neither borrower nor lender be." And that is good advice in general. In fact, never borrow money for a trivial purpose, such as a vacation, or for a risky venture, such as launching a business.
But there are some legitimate reasons to borrow money. That is why you got the credit card, and why you use it as described above. Using a credit card that way, you are not building debt. But you are building an excellent credit score in just a few years. And that will pay off when there is a good reason to borrow money.
When to Borrow Money
Good reasons to borrow money:
- To buy a house. Get a 30-year, fixed rate, low interest mortgage.
- For education through a good college, and for a higher degree if you have a career plan that calls for a higher degree.
- For a car, if you can't afford a cheap car on cash. Don't borrow money to buy a new car. Buy a used car 2-3 years old, and keep it in good condition.
- For emergencies, such as medical emergencies, or to cover bills when you are unemployed.
Because you want to buy a house, and you may want an education or a car, and emergencies do happen, you want an excellent credit rating. For example, a high credit score can save you close to $100,000 in interest on a 30-year mortgage by giving you a lower interest rate. That's why using a credit card just a little pays off big time when you need to borrow.
How to Invest in Pre-Purchased Life Insurance
There is one problem that makes this whole approach a lot harder now than it was back in the 1970s when Joe Dominguez came up with the idea. Back then, interest rates were very high. That was bad if you were in debt, but good if you had money to invest.
Now, interest rates have been very low. That's good if you have secured debt (like a mortgage on your house). But it's bad because you can't earn much on the kinds of secured, guaranteed investments you want to have.
But there is one exception. It's a secure investment loophole that the rich built for themselves. But if you learn about it (from the book by Douglas Andrew, above), you can use it.
Prepaid Life Insurance
When my mother retired, her parents died at about the same time. As a result, she had about $100,000 to invest. She used it to buy $300,000 in life insurance.
Well, that's great for us kids, when we inherit. But how does it do her any good.
It does her lots of good. Here's why:
- It's secure. Many banks failed in the Great Depression. But none one single life insurance company went out of business. Very strict government regulations on how insurance companies can invest their policy money made sure of that.
- It's insured. The government backs life insurance policies in a way very similar to the way it backs savings accounts.
- It's high interest. In fact, the investments are indexed to the Dow. That is, you earn the same as the Dow Jones indicator of stock prices, most of the time. Only, when the Dow goes down and investors lose principal, you're investment is locked in with no losses. And if the Dow goes above a certain cap - say, 15%, you earn only 15%.
- Your earnings lock in as principal each year. That is, if you invest $100,000 and earn 10% in the first year, then, the next year, your completely safe, insured principal is now $110,000. And that happens year after year.
- You can't take it out, but after 5 years, you can borrow against it tax-free.
If you ever do need this money, after the first five years, you borrow against it. The interest rate on the loan is identical to what you earn, so it's a no-interest, tax-free loan. That is, functionally, it's just like drawing the money out of a bank account.
Thanks to the work of Doug Andrews, this little secure retirement haven and tax shelter is available to everyone.
When to Invest in Pre-Purchased Life Insurance
You don't have to buy a whole policy in a single year. It's best to invest $100,000 or more in each policy. Now, if you've saved up a lot, or if you get an inheritance, you can just go buy the insurance right up. But say you're not there. Well, if you have a reliable job earning, say, $25,000 more per year than you need to live on, you can get the policy, and put in $20,000 per year over five years.
By the way, you can buy more than one policy. So, as more money comes in, you simply buy as many policies as you want.
There is one catch: You have to be healthy. If you develop a life-threatening condition, such as heart disease or cancer, you can't get life insurance. So stay healthy and buy early. (If that doesn't work out, you've still got the bank accounts. And there's an insurance-related product called an annuity. It's not as good as the pre-paid life insurance, but it might be right for you.)
So you have the whole plan. Review it in the table below and get going towards a safe, financially solid retirement.
The Steps to 21st-Century Retirement
Live Within Your Means
Earn More Than You Spend
It's the Only Way to Stay Out of Debt
Get Out of Debt
Use 50% of Net Revenue to Pay Down Debt
Debt is Expensive
Stay Out of Debt
Don't Borrow Unless You Must
Debt is Expensive
Build a Great Credit Score
Use a Credit Card, Pay Off Almost All
You Spend a Little on Interest and Save Big Time When You Buy a House
Borrow Only If You Have To
For a House, Maybe Education, Car, Emergencies
Interest on Debt for Luxuries is Doom for Your Retirement
Put Money in Insured Bank Accounts, CDs Money Markets
Secure Retirment: Guaranteed No Loss of Principal
Pre-Purchased Life Insurance
Book by Doug Andrews
Secure Retirement: Guaranteed, Plus High Interest