The Top Five Money Secrets of the Happiest Retirees, Part 2

Today it’s time to review more secrets of the happiest retirees from the book You Can Retire Sooner Than You Think.

We already listed the five secrets and detailed the first one in The Top Five Money Secrets of the Happiest Retirees, Part 1. 

Today we’ll discuss secrets 2 and 3.

How Much Do You Need to Retire?

Secret 2 is the fundamental money question of retirement:

Figure out how much money you need to have saved before you retire.

I’ve addressed how I recommend doing this in my free retirement email series. Now let’s look at what the book says.

I won’t cover all the tips (as if I could), but we’ll highlight a few principles.

The $1,000 a Month Rule

The first item is what the author calls the “1,000-bucks-a-month rule”. His thoughts:

Here’s how the 1,000-bucks-a-month rule works: For every 1,000 bucks per month you want to have at your disposal in retirement, you need to have $240,000 saved.

Consider why $240,000 in the bank equals $1,000 a month:

• $240,000 x 5% (withdrawal rate) = $12,000
• $12,000 divided by 12 months = $1,000 a month

Yes, 5% withdrawal rate. More on that in a minute. For now, let’s focus on the “rule”.

IMO, it’s not a bad rule, but I think we’ve put the cart before the horse. Isn’t step 1 to determine how much we need for retirement? After that, we determine what we need to save to support our lifestyle.

The book kind of assumes you know what you’ll need which I think is a faulty assumption. This is why I recommend people keep budgets a few years before retirement, so they have a firm grip on what they spend. This will help them create fairly accurate retirement budgets — something you want to do when you’re making the leap from the working world.

As for the “rule” itself, it’s fine IMO. Nothing special but not harmful either.

The next issue is a bit more controversial…

5% Withdrawal Rate

The book spends quite a bit of time talking about how a 5% withdrawal rate is acceptable. Here are the highlights:

Assume you have your retirement reservoir sitting in cash and yielding almost nothing (let’s assume 0 percent per year). Just taking 5 percent at a 0 percent interest rate, the funds will still last you 20 years. A level 5 percent withdrawal per year x 20 years = 100 percent of your funds withdrawn, and then the money is gone. This gives you two decades of using 5 percent of your overall portfolio as an income sources—not bad.

A 4 percent yield plus 1, 2, or 3 percent in growth over time suggests that you can take out 5 percent almost indefinitely.

So, if you have a portfolio that’s generating a full 4 percent in income, this is where the rubber meets the road. If you’re generating 4 percent per year (based on your principal), you are technically dipping into your nest egg little by little each year. In this scenario how long will your money last? The answer is more than 40 years. For someone retiring at age 60, this takes you beyond age 100!

Now if you increase your 5 percent withdrawal rate each year for inflation (using 2 percent inflation) your money lasts closer to 30 years. That’s still a very long time. However, in real life retirees adjust their spending over time, typically moderating expenditures to counteract inflation and naturally spending less into their 70s and 80s. Hence, using this rather conservative scenario sets you up for a very high probability of not running out of money.

Several thoughts on this one:

• Yes, the author has heard of the 4% “rule”. He spends some time addressing it and explaining why he goes with 5%.
• I’m hearing 5% as a withdrawal rate more and more. In addition to the above, the planners at our third retirement seminar used 5% in their calculations. I also recently read somewhere (can’t remember where, I’ve been reading so much lately) that someone else recommend it.
• Of course 5% is way more conservative than Dave Ramsey’s 8%. LOL!
• On the other hand, Larry Swedroe in the book Your Complete Guide to a Successful & Secure Retirement starts lower, especially for early retirees. His thoughts: “If you do not have access to a Monte Carlo simulator, are recently retired, or near retirement, we recommend that at age 65 you consider withdrawing just 3 percent a year from your portfolio, adjusting that each year by the inflation rate. You could increase that to 4 percent if you have options that you would be willing and able to exercise that would cut expenses should the portfolio be severely damaged by a bear market. If you are older than 65, the safe withdrawal rate increases as the portfolio does not have to support as many years of spending. At age 70, you can increase the safe withdrawal rate to 3.5 percent, at age 75 to 4.5 percent, and at age 80 to 6 percent.”
• Generally, I prefer to be conservative, so I’d use a 3.5% rate at the most. If you can make it with less, that’s even better — doing so can count as one of your margins of safety in case things turn out worse than you forecast.

Saving for Retirement the TSL Way

The author then suggests a budget split three ways that should set you up financially for a great retirement. He calls it the TSL plan which stands for “taxes, savings, life.” His thoughts:

The TSL approach is an easy way to split your money into three separate categories. I want to encourage my readers—especially those in their twenties and thirties—to strive for the following percent breakdown of every dollar they earn:

• Taxes = 30% to the fed and state
• Savings = 20% to a 401(k) plan or to pay down debt
• Life = 50% for food, housing, fun, and everything else

I have several thoughts on this:

• I like using gross numbers more than net, so I appreciate this approach. So many sites use net or switch back and forth between gross and net that it’s confusing. Besides, there’s no ambiguity with gross numbers. Net numbers can be manipulated based on what you deduct or don’t deduct from the gross to get net. It also seems like many bloggers use net numbers to make their savings rates look higher.
• Taxes are higher than most think. Include federal, state, FICA, and Medicare and they add up. Of course this doesn’t include the myriad of other taxes (sales, real estate, etc.), but those are deducted from “life”.
• We’ll address saving 20% of gross income in a bit.
• Living on 50% is more than enough, especially if you focus on growing your income. It’s a lot easier to live on 50% of $100k than 50% of $50k.
• I’ve shared our numbers previously: Savings: 36.1%, Giving: 26.0%, Taxes: 21.0%. This means our “life” percentage was 17%. This is what can be done when you make a lot and have no mortgage.

Saving 20% of Income

The book recommends saving 20 percent of income for retirement and includes the following quotes:

Twenty percent is a significant number, but take into consideration the many tax-advantaged ways to save—such as a 401(k), 403(b), 457, or a SEP IRA— and you can get there a lot faster than you might think. Which means, of course, you might be able to retire a lot faster.

If 20 percent seems unrealistic right now, just start somewhere and work up to it. Times takes time—and so does saving money.

I love these tips. I think 20% is both a reasonable number as well as adequate for most people who want to retire on time or even a bit early.

I also like the “just start something now and build it up over time” suggestion.

I’m a big fan of starting small and increasing as time passes. This process helps in many things — growing your career, accomplishing a large goal, and, yes, saving for retirement.

We employed the “start small and build” methodology for both saving and giving. We established levels we thought we could manage early in our marriage and added to them year after year until both our savings and giving were at substantial levels.

It took time, but this is a simple, effective, and practical way to eventually get where you want to be.

Marry for Money

As we move on into the topic, the author discusses the financial advantages of having a partner — and how it can make retiring easier:

Marriage is more economically efficient and cost-effective. Financially, a marriage is about economics of scale. If you have two people adding money to a retirement fund, it grows a lot faster. This is a big reason why so many of the happiest retirees are married. A marriage is about love, romance… and two incomes.

We didn’t have two incomes for much of our marriage (just the first few years), but our partnership was certainly vital to our financial success.

I was great at playing offense and my wife was great at playing defense.

In other words, I made a lot of money and she was frugal with it. This allowed us to open up an ever-increasing gap between what we made and what we spent. As such, our savings and giving grew over time.

And yes, it’s helpful to have two incomes as well. Some people say they can’t grow their incomes or reach a decent level of pay, but one way for a couple to do this is for both to have average jobs. Two people making $50k each adds up to the same as one making $100k a year!

Watch Large Spending

The author rants a bit about small spending versus large items and where your focus should be.

His thoughts:

One of my biggest pet peeves is the notion that your latte habit is the reason you aren’t a millionaire. I don’t care what you do with your money—as long as you use TSL correctly and the discretionary money is going toward a life that is full of core pursuits. We know that the more hobbies you have, the happier you will be with your life. If being a latte connoisseur is a passion, go for it.

If you are pound-wise, you can afford to be penny-foolish. You can spend your pennies on whatever you want, as long as you get the big things right. One of the reasons I love my TSL guidelines is because they take away the guilt factor. As long as you are hitting your numbers, you no longer have to worry about what society deems wasteful. Fundamentally sound spending and saving habits—TSL— can make you the master of your own choices. Start following this advice today so you no longer have to drink that latte in a dark alley away from society’s judgmental gaze.

Haha! What do you really think?

Some comments from me:

• The latter factor is from The Automatic Millionaire and is not meant to be taken literally. Author David Bach is not anti-Starbucks. The idea is simply a metaphor for small spending, which can add up to big money if it gets out of control.
• I tend to agree with David’s thinking. Americans notoriously seem to over-spend in almost every category. So telling them they can spend as they want as long as they watch certain expenses is a no-go for me. It won’t result in what this book’s author thinks it will.
• That said, of course the larger expense items should have more weight — you always want to focus on the fewest things that have the largest impact. But you can’t ignore small spending either or it can kill you.
• I do agree that you shouldn’t beat yourself up for small spending here and there as long as you have a pretty good sense where your money is going and spend it intentionally. After all, no one wants to put in 40 years of penny pinching just to loosen the purse strings a bit in retirement.
• Again, a large income helps out here too. You have more leeway in spending the more you make.
• Budgeting is the key to knowing where your money is going and controlling it. The more you budget, the more control you have. That said, millionaires generally don’t budget. Yes, they are leaking money here and there but they have a general sense of what they can spend and since they make enough, they can afford it. This is the same for us — we had a budget when we needed it (at the start of our marriage and as we approached retirement) — but otherwise did not use one.

What’s more controversial than budgeting? We’re about to find out…

Pay Off Your Mortgage Early

Secret 3 is bound to cause some angst. 🙂

It states:

Pay off your mortgage in as little as five years.

The author knows that a lot of people hate this suggestion (as they prefer to keep a low interest mortgage and invest instead), so he spends considerable time on it.

Let’s start with the advice:

Why do I feel it’s so important to turn your mortgage into ancient history? Sooner or later, every homeowner asks if he should or shouldn’t and is bombarded with a variety of complicated, hedged responses. Let me offer the simplest possible answer: Yes. If you are anywhere near retirement and can afford to pay off your mortgage, do it.

All the successful retirees I’ve known—the folks who are living their dreams—have eliminated or dramatically reduced their mortgage payment before pressing the retirement button. Paying off a mortgage by the time you retire will bring you enormous peace of mind by dramatically reducing the amount of income your nest egg must produce to create a sunny-side-is retirement. The data from my survey brooks no objections: happiness levels rise undeniably as mortgages vanish. And why not? A mortgage at its simplest, is a large amount of debt. Who wouldn’t be happier without that hanging over their heads?

After this, he addresses the counter argument:

Conventional wisdom says that if you can earn a higher rate or return on your investments in the stock market than you are paying in interest cost on your mortgage, then you should keep the mortgage.

Then he lists reasons why paying off the mortgage is better:

1. What if the stock market doesn’t go up for a year or two…or three or four or five?

2. The average investor is not making a steady 8 percent per year, so why would we advise people to trust the market rather than paying off their mortgages?

3. Furthermore in “real life,” most people don’t have 100 percent of their money in stocks, and those who do probably end up timing the stock market poorly.

With that in mind, advising people to not pay off something that is costing them a known 4 or 5 percent (and in many times over history, higher than that) and betting on the unknown possibility of 8 percent is an argument that falls on deaf ears for me. I just don’t buy it.

Then he dives into the benefits of paying off a mortgage:

Now, here’s what I do buy: that paying off your mortgage will make you a whole lot happier in retirement. Consider the following two benefits, for starters:

It’s obvious—you are no longer paying interest to the bank.

Paying off your mortgage gives you the budgetary freedom to spend more money on finding purpose and happiness in life.

Next he suggests people follow the One-Third Rule:

Can I take one-third or less of my after tax money to pay off my mortgage? If the answer is yes, do it. If the answer is no, don’t. Instead, look at accelerating your monthly payments by a few hundred dollars a month.

He also shares several other thoughts on why retirees should pay of their mortgages as follows:

If I’m not paying that mortgage note anymore, it lowers my spending tremendously and puts less pressure on my overall financial plan. Think of your retirement assets as any engine. You’re no longer working, so that engine has to function with the finite amount of oil already in it.

What no one else talks about when giving mortgage advice is that the psychological burden that comes along with having a mortgage, and the subsequent release people feel when they’ve paid it off.

The happiest retirees care more about happiness than risking engine failure for just a few more shekels.
From all my years of experience in this field, I can tell you that the best move overall is to pay off that mortgage by the time you retire (if you can). The financial and psychological factors both play huge parts.

What I’m trying to do is pass on the secrets of very happy and successful retirees. You might like what I’m saying and you might not, but you can’t argue with the fact that these are the behaviors and habits happy retirees have in common. It’s clear a majority of these happy people no longer have mortgage payments. Of course, it’s possible to be happy with a mortgage. But the percentage of possibility is lower, so why take the risk?

Lots of thoughts on this one. Here’s my (various) comments on the issue:

• Personally, I liked the fact that we paid off our mortgage early and haven’t had one for mostly 25 years. Our decision was more of a no-brainer since our rate was something like 8% back in the stone age.
• That said, I think we’d pay it off early even today. I know that you can look at historical data and say it would be better to keep investing more, but we all know that past performance is not a guarantee of future results. Besides I wouldn’t really have a choice. My wife hates debt even more than I do so if we had a mortgage today, we would be paying it off.
• The biggest issue I see is that if you invest, your money can compound longer. You can minimize the impact of not investing (and paying off debt first) by paying off your mortgage quickly. Then you’re only giving up a small amount of time/compounding.
• The key to paying off a mortgage early is to buy a house you can easily afford. If you do that, the rest is much easier than most imagine.
• I must agree with his take regarding the psychological factors of paying off your mortgage. It’s hard to describe not having a mortgage to those who do, so let’s just say it feels like complete freeeeeedom!
• Paying off a mortgage is a guaranteed return, while stock investing is not (especially in the short term). It’s not a high guarantee given that rates are so low, but perhaps it could be justified by lowering stockpiles of cash (which can’t even earn 2% these days).
• Once again, having a high income allows you to save, pay off debt, and give all at the same time. Anyone sensing a theme here? Is there any reason I push earning so hard?
• Do most people have the discipline to invest if they don’t pay off their mortgages? Many folks will say they are forgoing a mortgage to invest but will then spend the excess, making them no better off. Pre-paying a mortgage is forced savings. We know Americans as a whole are terrible at discipline, so how many will really invest versus blowing it?
• In the end, I don’t think there’s a right or wrong answer, and people need to choose their own path. Either way (paying off the mortgage or not paying it off) can work out if done correctly.

I’m sure there will be a lot of conversation on this in the comments.

Say No to a Second Home

The author winds up secret 3 by talking a bit about buying (or not) a second home in retirement. Some thoughts:

In today’s world, I’m not sure it’s necessary to have a second home. A lot of the happiest retirees still do, so it’s not a make-or-break situation, but if you want to shed the mortgage payment on that beach or mountain home, VRBO allows you to enjoy vacations without being tied to anything.

Remember the overall concept that your mortgage is most likely your biggest expense—the biggest potential black hole for your finances. And don’t forget that in addition to the mortgage, there is a litany of expensive problems that can go wrong with your home.

This is where we have netted out.

We once thought that we’d buy another property, but with more real estate comes more money, more time spent managing it, and more headaches.

Instead, now we simply rent a nice place on the beach for 10 days which is perfect for us. Next time, if the number of people coming changes, we can rent a bigger or smaller place. Or if we don’t like the location, we can change areas, cities, states, or countries.

Yes, renting is more of an expense than an investment (you could argue that a second home would retain its value whereas renting is money lost forever), but there are expenses associated with buying as well (taxes, insurance, maintenance, etc.) that aren’t recouped, and those are potentially as high as what we’d spend on renting each year.

Besides, renting gives us complete flexibility which is something I have really come to treasure in retirement.

That’s the scoop on secrets 2 and 3. Any thoughts on them?

To learn more secrets of the happiest retirees, check out part 3.