A good exercise on the Time Value of Money. At first blush is sounds like a no brainer, $1M is a lot of cash and a penny is not. While Albert Einstein may or may not have said that compound interest is the most powerful force in the universe, it is a pretty handy concept, especially for reaching Financial Independence and Retiring Early (FIRE).
Now to the math.
Were you surprised? Probably not. If you haven’t heard of this particular exercise you were still most likely able to determine that the most obvious answer wasn’t the correct answer.
So of what use is this? I’d have a tough time finding someone willing to pay me 100% DPR (Daily Percentage Rate) unless I was the world’s best loan shark. What this exercise is good for is as an introduction to the value of compounding and the time value of money. This can be a good exercise to do with children as they start to handle and make decisions about money. As I discussed in a previous post, my youngest son does best with saving his money when it is automatic and he doesn’t think about it. This works for adults as well.by Rich
The debt snowball method has been around for a while. It was popularized by personal finance guru Dave Ramsey.
The premise of the debt snowball is that if you have more than one instance of consumer debt (car loan, credit card etc.) you should pay off the smallest balance first, not the one with the highest interest rate. The idea here is that a small victory on a small balance will give you further incentive to keep working on paying off the next bigger debt. Additionally, you can apply the monthly payment that was going to the first small balance toward the next debt with its requisite payment allowing you to crush each debt with larger and larger monthly payment amounts.
Vertex42.com has a great Excel based snowball calculator that can show you how fast and how much interest it will cost to pay off all your debts. You can select the Snowball method as described above or the “blizzard” method which pays off the highest interest loans first, or a custom method you define. This is a handy tool for planning your strategy of escaping debt.
Vertex 42 has a lot of Excel templates and instruction if you are new to Excel or want to brush up on your skills/knowledge.
The main reason? Out of sight out of mind. He doesn’t think of it and consequently has a balance in the “bank” of over $150 in a few months of savings (some birthday money thrown in there too).
This is a perfect lesson on how we ought to save. Set up the money to come out of your paycheck before you even see it, or at least have it transferred before you can spend it. This is the old “Pay yourself first’ mantra. When you do this, you are much less likely to miss the money you never had. If you try to wait until the end of the month and save what’s left, you’ll end up with lint from your pockets.
I use a similar strategy with pay raises. As active duty military, we usually get a small percentage pay raise each Jan 1st. I just bump up my TSP amount to coincide and I never see/miss the pay raise. Same thing on even year anniversaries of my active duty service, I get a small bump in pay, just save it ahead of time.
What strategies do you use to “pay yourself first”? Tell me in the comments.by Rich
News Flash! Your military retired pay stops when you die!
The Survivor Benefit Plan (SBP) is a form of life insurance for your military retired pay that provides a percent of your retired pay to your spouse or other designee after you die.
In a nutshell:
You pay premiums starting at retirement for up 30 years out of your pension to cover this insurance. The premiums are pre-tax and lower your tax bill. Additionally, the government subsidizes the payments, so it is even cheaper than at first glance. For spouses it provides from a minimum of $300 a month up to 55% of the member’s pension for life. Your spouse’s signature is required to not select SBP.
There is a different formula used for percentage if you entered military service before March 1st, 1990.
Post-1990 example: A service member elects for full coverage of his $2200 a month pension payment. This will cost $143 a month and if the service member passes away, his spouse will receive 55% of $2200 or $1200 per month.
Rules: Sign up upon retirement or within 1 year of retirement.
For the Spouse option: If your spouse remarries before 55, SBP stops, after 55 it does not. If your spouse dies before you, your SBP payments stop.
Former spouse rules are similar to spouse except you have to provide a letter from you and your spouse to DFAS explaining the reason for the election (divorce agreement, voluntary etc.).
Children can be covered provided they are under 18 or until their 22nd birthday if they are enrolled full-time in college, the benefit only goes to the children if the spouse is no longer eligible (deceased or remarried if under 55). The children’s plan is very inexpensive. The premium is based on the service member’s age and the youngest child’s age at the time of selection of SBP.
Is SBP worth it? This depends on your financial situation. May not be necessary if your spouse has a successful career, or you have significant investments/insurance to cover expenses after you pass. If the money from your pension is an afterthought you may not need it. Your SBP payments are pre-tax and the government discounts the cost compared to a privately purchased annuity.
Can I sign up after I retire? For one year with a couple exceptions such as getting married.
What if I change my mind? You can sign up as stated above, you can exit between the 2nd and 3rd year anniversary of receiving your first pension payment. No refunds on previous premiums paid.
What if I remarry? You can sign your new spouse up.
What about Exceptional Family Members? If your child is permanently disabled, he/she can get SBP for his/her entire life! This can be a double edged sword as their income from SBP may make them ineligible for services such as Medicaid and Supplemental Security Income (SSI) benefit. You may want to consult with a special needs trust qualified attorney to discuss which options make the most sense in your family situation.
There are a couple other options for SBP for business owners with partners and such that I won’t cover here. This article is intended to be a quick intro to SBP, not an exhaustive overview.
Official Defense Website on SBP: http://militarypay.defense.gov/survivor/sbp/index.html
Military.com discussion: http://www.military.com/benefits/survivor-benefits/sbp-child-coverage-cost-and-benefits.html
Good article on special needs/exceptional family member cases:
Disclaimer: I am not an expert on SBP, special needs trusts, or much of anything.
An average healthy meal (salad) at my work is about $10. I can bring my own for less than $3. So $7 a day for 4 days a week is $119 at 6.5% interest (reasonable investment return) = $20,267.53 at the end of 10 years. Which would you rather have, $20 grand in the bank or memories of daily food purchases at work for 10 years?
Of course if you regularly buy breakfast at work and eat dinner out a couple times a week, the money can add up even faster. This isn’t to say that you shouldn’t be able to treat yourself to a nice meal, but if you do it every day, is it really that special?
Making my lunch takes only a couple minutes in the morning, even less if my leftovers have survived the teenage pillaging of my refrigerator. Sometimes it is a salad, sometimes a can of soup and a couple pieces of bread.
My goal is that lots of little life changes and a few big ones will allow me to save more to bump up that retirement date.
Based on recommendations from MMM, I’ve recently bought myself a road bike and I’ve been slowly working my way up to riding more. This week, I rode my bike to work and back two times (full disclosure, I drive my car 4 miles to the Mount Vernon Trail and park then bike the remaining 9-10 miles).
The two main benefits of biking to work are saving money on gas/wear and tear on my vehicle and I get a great workout during my commute. This week’s riding works out to 48 miles which I didn’t put on my car.
Above is the bike I bought, an entry level road bike from Nashbar.com. They regularly run sales, so I timed my purchase with a 20% off option and got the bike for less. I’ve since changed out the pedals to clip-in style and the tires to Continental Gatorskins (kevlar lined to minimize flats) and I’ve added some lights and a handlebar mirror.
I opted for a road bike over a mountain bike since I have a fairly long ride and the trail is well-paved. The road bike affords me greater speed so the ride goes a little quicker than it would on a mountain bike.
Biking to work won’t work for everyone, but especially if you have a biking trail that covers a big chunk of your commute, you can really gain benefit from taking advantage of it. I’m fortunate in that the trail I use runs all the way to the Pentagon where I can park right outside our Athletic Center and grab a quick shower on my way to work.
I use the app Runkeeper on my smart phone to track my time/distance/calories burned. Works great!
So what does this have to do with retirement? Less driving = less money spent and exercise = healthier Rich!
I’d love to hear from you in the comment section about biking and other non-conventional ways you get to work.by Rich
Should you view your military pension or any other government guaranteed pension like Social Security like a large investment in bonds? The definitive answer is…it depends.
Some folks make the case that since your pension is guaranteed by the government, it is very similar to buying a number of Treasury Bills and that you can adjust your portfolio mix between stocks and bonds to account for this large cache of bonds.
Others like Ric Edelmen say that since you can’t buy or sell them it doesn’t count as part of your portfolio, you just subtract your pension from your desired annual income to figure out what you properly diversified portfolio amount should be to retire.
Nords takes the view that your pension can satisfy your bond requirement if you keep 2 years of expenses out of the stock market to account for volatility. Others say your time horizon should be much longer– say, 10 years to properly account for stock market volatility.
I think between the natural tendency to reduce spending when your investments are down which we discussed in this post and keeping a certain amount of money in cash to account for the variations in the market, a pensioner can take a more risky position with their investment portfolios than someone living solely off their retirement savings.
In my case, I hope to live off only my pension and any part time work I do for the first 10 or so years after retirement from the Navy. Consequently, I plan to keep my portfolio mix highly weighted towards equities with only small bond positions.by Rich
In 1998, Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz, wrote a paper called “Retirement Savings: Choosing a Withdrawal Rate That is Sustainable,” This paper is commonly referred to as The Trinity Study as all three were at Trinity University when they published the paper.
The main thesis of the paper is that a 3-4% withdrawal rate would allow the average retiree enough money to live 30 years in retirement. Another way to put the 4% rule is to accumulate 25 times the assets you need for an annual income in retirement.
As an example, to live on $60,000 a year would require 60,000 X 25 = 1,500,000 or $1.5 million according to the study.
Since publications, the study has been referred to numerous times as a guideline for retirement. It has also been widely criticized as unsustainable in the long term, especially if you want to retire earlier than the typical 65, you might find you need more than 30 years worth of retirement savings.
The study referenced data from 1926 to 1995 and 1946 to 1995 and looked at the percent of years various withdrawal rates would support assuming certain portfolio mixes between stocks and bonds. Stock heavy portfolios fared better than those with higher mixes of bonds with the greater risk associated with a stock heavy portfolio.
Of course, one of the facts of retirement not accounted for directly in the study (but referenced in the Trinity discussion) is that retirees may modify their withdrawal rate to account for variations in the stock market, taking a smaller withdrawal in bad years and returning to the standard withdrawal in good years.
Another big assumption of the study is that you will have a good run at least the first few years of retirement, giving your investments a good opportunity to grow well at the beginning of your retirement. If you retired in 2008, that was not the case.
Lots of folks have written on the topic, Doug Nordman of the Military Retirement and Financial Independence blog has written extensively on the topic. Here is one of his articles. The Bogleheads (named after John C. Bogle the founder of the Vanguard Investment Group) also have extensive articles on the topic: here’s one.
So if you have a military pension, how do you account for that in your calculations? Just subtract the annual amount of your pension from your required (desired) income in retirement before multiplying that amount by 25 (good news if you are planning a military retirement and don’t have $1.5M sitting in the bank at the moment).
Next retirement focused article will be on the military pension and how it impacts your portfolio mix (does it make you heavy in bonds since it is backed by the federal government like a Treasury bond?).
The best way to estimate your military pension is with one of the calculators available on militarypay.defense.gov. For most folks in the window to retire, the High-3 plan will apply where you receive the average of your highest 3 years of base pay on active duty (usually your last 3 years).
You plug in your retirement year (or estimate) years of service, grade, and then estimate inflation and pay raises plus your tax rate after retirement to generate a fairly lengthy output. There are several graphs of how much your retirement amounts will increase over time and such, but the most important chart is at the very bottom and it is labeled Summary Results Table. This chart shows your your monthly and annual pay before and after taxes and provides an estimate of how your pay will change based on the active duty pay raises you selected.
So now you can calculate what your pension will look like with various scenarios on inflation, cost of living increases and tax scenarios. Some states either don’t have a state income tax or exempt military pensions and these facts are important to consider when you are picking your retirement location.
In this scenario, the pension isn’t enough for an average family to live on without some pretty severe belt tightening, but it provides a nice supplement to either a second career income or to offset the amount of retirement savings or other income producing investments (such as real estate) you have to draw from upon retirement.
The best characteristic of the military pension is that it represents a government backed annuity with guaranteed cost of living increases.
Next post we will punch some numbers on example retirements.by Rich
I recently had my eyes opened on retirement. I was trudging along planning to retire from the Navy with a generous pension and then get a “beltway bandit” job at a defense contractor to rake in some big cash before I permanently retired. Now, I might find myself going down the contractor path, but as of right now that is not my plan.
After some research I discovered I might be able to just retire from the Navy.
Currently, we live in Northern Virginia and the cost of living here is very high. Way too high to retire on just my Navy pension. That’s ok as my wife and I have no intention to retire in this area. We are looking at several locations, our most promising current locale is Northwest Washington State. My goal between now and retiring from the Navy is to save for a big down payment on a house in the Pacific Northwest.
In this blog post I want to discuss some the websites I peruse regularly for financial/retirement advice, some of the calculators available online and budgeting options, to include Excel spreadsheets and paid for software.
So the first site I stumbled upon for the topic of early retirement was a guy who calls himself Mr. Money Mustache (mrmoneymustache.com). His blog focuses on budgeting, cutting costs and retiring earlier. MMM and his wife retired at 30 to raise their son. Their current annual budget is $27,000 (they own their home outright). MMM has been featured on a slew of financial, self-help and news sites/programs, most recently in a Washington Post article (http://goo.gl/FcuQk).
His frugality may be more than some folks (your dedicated scribe included) can live with, but he provides some great motivation with financial “face punches” to folks spending huge amounts of money and working their entire lives to maintain a ridiculous” Exploding Volcano of Wastefulness”.
MMM has over 300 blog articles and a very active forum of “Mustachians” who share advice and “badassity”. A great group of folks.
Next up is The Military Guide website (http://the-military-guide.com) Doug “Nords” Nordman has literally written the book on military financial independence (http://goo.gl/ur3HY). He and his bride are retired (he from active duty Navy, she from the Navy Reserves). They live in Hawaii, where he splits his time between surfing, managing a rental property and running a kickass website/blog.
Nords posts tend to be more aligned with military financial independence and retirement, but he still covers a lot of ground of great use to almost anyone. He is a regular poster on many other sites (to include MMM, where I first found out about him). His posts are very well written and very entertaining.
There are a slew available online. I’ll discuss two I really like.
Todd R. Tresidder is the owner of financialmentor.com and a financial coach. His website provides a plethora of advice and some of the best financial calculators out there. My favorite is his Ultimate Retirement Calculator, http://financialmentor.com/calculator/best-retirement-calculator
This calculator asks for your age at the end of the current year, age to retire, life expectancy, annual desired income and allows you to input several variables, such as cost of living adjustments to pensions, expected rate of return, expected inflation etc. It is a fairly comprehensive calculator, but lacks any type of historical averaging or Monte Carlo simulations, it just runs the numbers against your predicted returns. The lack of historical returns is on purpose, Todd does not think it is particularly relevant. It is a great calculator to run various dollar amounts through as far as how much income you will need, what size estate you want to leave etc.
Nords did a great review/explanation of Todd’s calculators here (http://goo.gl/BHigD)
Firecalc http://www.firecalc.com/ is a very powerful retirement calculator that runs your predicted finances through scenarios involving data from every year since 1871. The end result looks like a kid’s Spirograph gone horribly wrong, but will show you the percent chance your retirement plan will work across all the years. This is handy to give you a percent chance your savings and spend plan will support you your entire retirement. If your plan survives contact with the crash of 1929 you are probably in pretty good shape!!
There are a bunch of financial calculators available, and I have only listed two. They are my favorite and you should try several to see what works for you. It is important to understand the investing philosophy of the owner of the calculator and ensure that philosophy aligns with yours.
I have toyed with many budgets over the years with limited success. Once my wife and I got serious about this new retire early plan, I modified an Excel based monthly budget and started using it.
What really made it much more effective than previous attempts was one important change to my system. Previously we spent pretty much what we wanted and did our best to pay off debts early. With the new system, my wife and I agreed to pay ourselves an allowance every two weeks. This allowance was automatically transferred to our own accounts to be spent however we wanted. Everything else in the main checking account went to monthly bills and investments.
This has worked very well to help us pay off debts and get our financial house in better order.
Recently, I purchased YNAB – You Need a Budget (youneedabudget.com) This is a software budget system(cost is $60) and focuses on giving every dollar a job by budgeting. The other goal of YNAB is to get you out of the paycheck to paycheck cycle allowing you to get a month or more ahead.
I am fairly new to YNAB, but really like it. The software has a broad following and a strong forum community to answer questions as well as lots of free training to go with your software. Definitely a community feel and focus.
Here is my affiliate link which will get you $6.00 off the price (full disclosure, it gets me $6 as well!) http://ynab.refr.cc/WJ2XRXZ
So that is a very quick rundown of various sites and software I’m using to chart my family’s plans for the future. Future posts will run some example retirement scenarios to see how they work.
I’d love to hear from you on your retirement plans and goals in the comments section.