I'd add a few things that I've learned over the years:
1) Always be invested in the market. Corollary, don't time the market. This is by far the largest mistake people make.
Investors typically pull money out at the bottom after they've suffered a physiologically devastating loss, like at the end of 2008 and hence they miss the rebound, like 2009-now.
This isn't quite the same but it shows what missing the top 25 days in the market over the past 45 years does to your returns.
If you are an investor you need to be in the market, period.
2) Accept that you will lose money some years. If you are buying index funds then you will get market performance, ex fees. Markets go down sometimes. Stay the course.
3) Don't look every day or you will go nuts.
Keep in mind that the largest draw down (top to bottom) will be larger than what the returns look like if you just look year over year. Ie if you look and see the S&P lost 28% in 2008, understand that if you watched the S&P every day of 2008 then it probably lost more than 28% from its top to its bottom but rebounded slightly at the end of the year to make the year over year loss less than the maximum loss.
4) Have some exposure to outside of the US markets. Consider the scenario of investing all your money in the company you work for. In a rough time for your company you get the double whammy of losing money and possibly your job at the same time.
Similarly to how you are told to not invest all your money in the company you shouldn't invest solely in the country you live in, same principle.
EDIT see child comment, I mangled the English language in point 4
Read Goldstein's (edit: Bernstein's!) book "If You Can".
It's a whopping 16 page book of plain talk and he made it free on the internet, no strings. [1] It's the best introduction to planning for retirement, especially for those under 35, I've read so far.
Holy shit this is amazing. Thanks for this link. Helped tie together a bunch of scattered finance knowledge I've 'acquired' (or encountered in the wild I guess).
I agree with most of this, except for the stuff on robo-advisors. You should be very careful about those.
First of all their fees are too high. Wealthfront's 0.25% fee seems rather small and it is smaller than what a lot of human advisers charge, but if you compute it over a lifetime of savings with the negative compounding effect it will cost you a lot.
Imagine you receive some money when you are 20 from a rich uncle and invest it for 40 years using the wealthfront fee structure. After 40 years you will have paid about 10% of your savings in fees. Or, in other words, you will have about 10% more savings if you had taken a couple of hours to sit down and decide which funds to invest in. Keep in mind that the wealthfront fees are in addition of any etf or mutual fund fees you have to pay to get into investment vehicles.
So yeah, compounding interest is a dangerous thing.
There is another problem with roboadvisers -- people put too much trust in them. In our society there is this implicit trust of the computer, probably bred from multiple sci-fi shows with all-wise computers. Well it is a very dangerous thing when it comes to your savings.
You may not be the best investor, but you should take responsibility in your investment choices. You should know what you are investing in and why. Even if the thing you are investing in is a boring simple S&P 500 fund (as it should be for most of you) you should know what it is and why you are investing in it. You shouldn't just blindly follow some algorithm programmed by god-knows who.
If you're healthy enough to swing a high-deductible health plan, consider maxing out a "stealth IRA" aka health savings account. With a $3,350 individual / $6,750 contribution limit, it's a great tax-advantaged account that can be treated just like a Traditional IRA. If you use it for medical costs, which you are likely to have in retirement, you get tax advantage on both ends.
As with all trustee-run plans, people should evaluate the investment options before moving the money in. The HSA I personally have access to is great for saving taxes on expenses, but if I wanted to use the investment options rather than sit in cash, my only options are high-fee managed funds (there's a lot less pressure on these vendors than on 401k trustees due to less public awareness)
It's like a traditional IRA, but the age for penalty-free non-healthcare withdrawals is higher (65 vs 59.5). Just something to keep in mind if you're older and think you might need the money sooner.
> You should open a SEP-IRA, which is a special account type that is similar to a 401k in mechanics but has very, very generous funding limits.
Actually, both account types have the same yearly limit; it's just that the employer can contribute much more than the employee, and when self-employed you can contribute as the employer.
In fact, the difference between SEP IRA and 401k is not the funding limits, but the fact that the SEP IRA allows only employer contributions. You can actually open a "solo 401k" for yourself if you are self-employed, and make both employer and employee contributions. That will let you put more money away for a given income than the SEP IRA, until you make 275k or so at which point you have hit the cap for both (and the cap is the same for both).
Edit: Vanguard has a calculator to show the difference:
This is exactly right, although with solo 401k, you can hit the cap of $53k contributions with net profit of only ~$185k, not $275k, if you max both employee and employer contributions.
Additionally, with a solo 401k plan, the $18k employee contributions can be Roth.
> Often when I told people I was building a (toy) stock exchange they’d ask me for stock advice, which is about as well-considered as asking a WoW guild to deal with your terrorism problem.
And you think that's problematic? I have relatives telling me that they'll go with X anti-thrombotic therapy because a cousin of the brother of a guy who they met in the supermarket took it 6 years ago and worked wonders for him. I'm a pharmacist and I have rather strong opinions about some drugs over others, but I can take advices from doctors, physicians, nurses or anyone with a minimum degree of knowledge on the topic. Still, many times I have to argue with with relatives, to the point where I get frustrated.
Question - is it fair to use the 8% historical market average when doing these calculations (which include some of the most spectacularly productive periods in the American economy)? All the predictions I've seen going forward look like the average will be much lower (at least for the current generation), and a rate of 4-5% means you need a much larger nest egg to drawdown a livable amount each year in retirement.
Edit: It's not clear from the essay, but I'm assuming Patrick's 8% rate is not adjusted for inflation (based on his 40k drawdown scenario - the other 3-4% would cover inflation).
> "Open a traditional IRA or a Roth IRA. The traditional IRA contributes pre-tax money, the Roth IRA post-tax money. The upshot is that if you believe your marginal rate at retirement to be higher than your present rate, you should pick a Roth IRA, otherwise, you should pick a traditional IRA. If you don’t feel like forecasting that, take my word for it that 90% of you should have Roth IRAs."
I simply cannot fathom why he would state that. I cannot imagine a scenario where my retirement income would (nor should) be as high or higher than my peak earning years.
Typically in retirement you have a home and all sorts of hard goods (clothes, furniture, cars) paid off and thus need less money.
Income early in one's career is typically lower than incomes later in one's career. So even if retirement income is lower than final career income, there's still a good chance it's greater than entry-level income and would be taxed at a higher rate. You've also got to keep in mind that taxes may eventually rise. America's top rate today is much, much lower than the top rate historically--no reason to believe it couldn't swing back the other way.
I think it's incorrect to compare marginal rates as well. It makes more sense to compare your Effective Rate in retirement versus your Marginal Rate of today. This article explains the math: http://www.gocurrycracker.com/roth-sucks/
Your effective tax rate is likely to be much less than your marginal rate.
Also, for anyone interested in financial independence and simple investing with your 401k and IRAs, I'd like to recommend the Stock Series here: http://jlcollinsnh.com/stock-series/
1) His audience is all tech workers, and
2) all tech workers are making better than $62k (single earner) or
whatever the higher married-jointly exclusion is.
The only situations I can think of where Roth might make sense are 1) early stages of your career, before you hit the 28% marginal rate and 2) if you are still eligible for a Roth, but already maximized your other tax-advantaged space in 401(k)s and IRAs.
One issue with the Roth is the amount you can contribute phases out with increasing income, to the point that you can't contribute if you file single and your income exceeds $132k (or $194k for joint filings).
Also neglects to mention you can have a 401k and a Roth IRA and that if you have a spouse with income they can open up a Roth as well. For financial advice I think it's really important not to miss details like that.
Also an HSA can be used to shelter a bit more income. If you don't consume much health care a HDHP may be the way to go.
There is also the backdoor Roth, but I never wrapped my head around it.
Even if you can guarantee that your retirement income wouldn't be higher, you can't guarantee that your tax would be lower either. So I'd have both traditional and Roth IRA (e.g., 50/50)
not mentioned is the income limits. Almost every engineer I work with is over the limit for Roth, and definitely over the limit for deductible tira. Non deductible has very little benefit, so might as well go with Roth, or back door into a Roth.
I look at it as diversifying against tax law going crazy though, siNce so much of my retirement income is in 401k and pretax. Also the limits are a third of 401k, so it's only a quarter of retirement savings, and principal can be pulled out if needed.
You can take your contributions (the principal, not the growth) out of a Roth account before you reach retirement age. The exact rules are complicated, but that's the big core benefit that has me putting money in a Roth. I can use it to retire at 40, or cash out some of it to make a down payment on a house.
As some others in this thread have said (and Patrick discusses in the post), there are lots of things you can do to much more directly impact your change of becoming rich and retiring well/early than optimizing your investments: get a really good salary and don't spend a lot of money. One blog which I have read is Mr Money Mustache [1], which focuses on those same concepts. Many of the posts are good reads.
This site was a eureka moment for me, but I've yet to convince my wife that every sacrifice is worth it - and I don't blame her. The comments/forum on the site are some good reading too, tho I think the guy did get a little lucky along the way.
If nothing else, that site made me realize where i stood on the consumer/producer scale, and what i needed to do to feel better about my future.
I don't really agree with that. Investing well is almost always more important than worrying about small expenses. Do you know how many people don't invest? Like, 99% of people.
Something else I would add - if you're working in the ups-and-downs world of startups and technology, you may have meaty and lean years and during the good years find you want to save more fore retirement than 401ks, SEP IRAs and ROTH IRAs (if you're not priced out) allow.
One handy way to extend your tax-advantaged space: buy Series I and Series EE bonds from Treasury Direct. Both are tax-deferred until you cash them in. You can purchase up to 10K of each type per year. They are government-backed, highly-safe fixed-income instruments.
I bonds will pace inflation (like TIPS) for up to 30 years. EE bonds have low 'normal' yields but they automatically double after 20 years (so around 3.5%/year annualized, better than the rates on 20-year Treasuries). These rates are better than what you get on the open market.
And unlike normal bonds, they won't kick out payments that are taxable along the way - you can save the tax bill until you have a lean year then cash them back out (in the case of I bonds at least), or save them to the end of their lifespan (or until they double in the case of EE bonds).
Bonds are a horrific investment in today's market. Rates are lower than they have been since WW2 when they were fixed by the government! The principal and interest risk for owning bonds is essentially at an all time high. You'd literally be better off in cash in rates rise even somewhat in the near future.
By loans you mean the mortgage too? Pay that off first?
In Australia you could pay off your mortgage then refinance in a brand new loan to buy investments. The interest you pay on THAT loan is income tax deductible.
I want to ask something. People always ask me why I rent and "waste money" instead of getting a mortgage etc.
I explain to them that I put most of the money I make into my company, and have a greater ROI than if I put the money into real estate. But, since I have to live somewhere, I rent.
Yet, I am not sure this argument is correct. If I had money for a down payment, perhaps the strategy of getting a mortgage would win in the long run. So, instead of getting into the details, I usually mention I also like to be able to change apartments every year or so.
What are your thoughts - those of you who have now, or have had, growing startups?
I'm on our company's 401K plan. If you know nothing about how the stock market works, then the target date retirement fund is the way to go. The worst thing you could do is not participating in your company's 401K plan, especially if the company offers you matching dollars (Read: FREE MONEY). I started with a target date retirement fund (managed by Schwab) but almost 2 years ago, I decided to re-allocate my fund into 3 mutual funds: S&P 500, US Small-Mid Cap, and International Large Cap. I'm happy that I re-allocated my fund. Ramith Seti's "I will Teach You to be Rich" book inspired me. And, another influence that made me re-allocate my fund is the "Three-Fund Portfolio" principle by Boglehead's Guide to Investing. I don't currently have access to the funds that Bogle suggested, but if I have extra money to invest, I'd open a Roth IRA account (alongside my 401K) and do the following:
VTSMX 60%
VGTSX 30%
VBMFX 10%
or ETF's
VTI 60%
VXUS 30%
BND 10%
These allocations follow the Boglehead principle of 3-Fund portfolio / Lazy portfolio
It's a good investment guide, but I disagree with Patrick's advice on Roth IRA. Roth IRA (unlike Traditional IRA) almost never makes sense.
It is very unlikely that tax rate at retirement would be higher than tax rate now, because if your income at retirement is already high (meaning high-tax rate) then you are very unlikely to get money out of your retirement fund.
You are much more likely to get money from your retirement fund at your low-income years, when tax rate is quite low already.
From personal experience, before you put all your spare money in the stock market, make sure you have the basics covered. Ask yourself, "What would happen if my partner or I couldn't work for a few years?"
Money: Set up life insurance, income protection insurance, and decent medical coverage.
Accommodation: You don't need to own your own home, but have some money available to cover rent or mortgage if needed.
Social: Don't let your social life revolve exclusively around work colleagues. Invest time in family and broader groups. Find a way to have achievements outside of work.
So this happened to me. My wife and I went from a very comfortable double income to countless hospital visits and no time or energy for anything else. And this is just after we had kids.
I'll be forever grateful that my wife set up the safeguards above. I was 100% invested in work, financially and socially, so it has been a huge shock and could have been much worse.
I am surprised by the 90% should invest in a Roth IRA vs. Traditional if they do not have access to a 401k. I would expect the growth of pre-tax dollars would outweigh having to pay taxes when I withdrawal. Put another way, I expect my retirement income to be 1/2 or less than my current income...
[+] [-] chollida1|9 years ago|reply
I'd add a few things that I've learned over the years:
1) Always be invested in the market. Corollary, don't time the market. This is by far the largest mistake people make.
Investors typically pull money out at the bottom after they've suffered a physiologically devastating loss, like at the end of 2008 and hence they miss the rebound, like 2009-now. This isn't quite the same but it shows what missing the top 25 days in the market over the past 45 years does to your returns.
http://www.marketwatch.com/story/how-missing-out-on-25-days-...
If you are an investor you need to be in the market, period.
2) Accept that you will lose money some years. If you are buying index funds then you will get market performance, ex fees. Markets go down sometimes. Stay the course.
3) Don't look every day or you will go nuts.
Keep in mind that the largest draw down (top to bottom) will be larger than what the returns look like if you just look year over year. Ie if you look and see the S&P lost 28% in 2008, understand that if you watched the S&P every day of 2008 then it probably lost more than 28% from its top to its bottom but rebounded slightly at the end of the year to make the year over year loss less than the maximum loss.
4) Have some exposure to outside of the US markets. Consider the scenario of investing all your money in the company you work for. In a rough time for your company you get the double whammy of losing money and possibly your job at the same time.
Similarly to how you are told to not invest all your money in the company you shouldn't invest solely in the country you live in, same principle.
EDIT see child comment, I mangled the English language in point 4
[+] [-] loteck|9 years ago|reply
It's a whopping 16 page book of plain talk and he made it free on the internet, no strings. [1] It's the best introduction to planning for retirement, especially for those under 35, I've read so far.
[1] https://www.etf.com/docs/IfYouCan.pdf
[+] [-] cesarbs|9 years ago|reply
[+] [-] etjossem|9 years ago|reply
[+] [-] anotheryou|9 years ago|reply
[+] [-] rublev|9 years ago|reply
[+] [-] hristov|9 years ago|reply
First of all their fees are too high. Wealthfront's 0.25% fee seems rather small and it is smaller than what a lot of human advisers charge, but if you compute it over a lifetime of savings with the negative compounding effect it will cost you a lot.
Imagine you receive some money when you are 20 from a rich uncle and invest it for 40 years using the wealthfront fee structure. After 40 years you will have paid about 10% of your savings in fees. Or, in other words, you will have about 10% more savings if you had taken a couple of hours to sit down and decide which funds to invest in. Keep in mind that the wealthfront fees are in addition of any etf or mutual fund fees you have to pay to get into investment vehicles.
So yeah, compounding interest is a dangerous thing.
There is another problem with roboadvisers -- people put too much trust in them. In our society there is this implicit trust of the computer, probably bred from multiple sci-fi shows with all-wise computers. Well it is a very dangerous thing when it comes to your savings.
You may not be the best investor, but you should take responsibility in your investment choices. You should know what you are investing in and why. Even if the thing you are investing in is a boring simple S&P 500 fund (as it should be for most of you) you should know what it is and why you are investing in it. You shouldn't just blindly follow some algorithm programmed by god-knows who.
[+] [-] teej|9 years ago|reply
http://whitecoatinvestor.com/retirement-accounts/the-stealth...
[+] [-] tcoppi|9 years ago|reply
[+] [-] torkins|9 years ago|reply
[+] [-] loeg|9 years ago|reply
[+] [-] hundt|9 years ago|reply
Actually, both account types have the same yearly limit; it's just that the employer can contribute much more than the employee, and when self-employed you can contribute as the employer.
In fact, the difference between SEP IRA and 401k is not the funding limits, but the fact that the SEP IRA allows only employer contributions. You can actually open a "solo 401k" for yourself if you are self-employed, and make both employer and employee contributions. That will let you put more money away for a given income than the SEP IRA, until you make 275k or so at which point you have hit the cap for both (and the cap is the same for both).
Edit: Vanguard has a calculator to show the difference:
https://personal.vanguard.com/us/SbsCalculatorController
[+] [-] ryanwaggoner|9 years ago|reply
Additionally, with a solo 401k plan, the $18k employee contributions can be Roth.
[+] [-] atmosx|9 years ago|reply
And you think that's problematic? I have relatives telling me that they'll go with X anti-thrombotic therapy because a cousin of the brother of a guy who they met in the supermarket took it 6 years ago and worked wonders for him. I'm a pharmacist and I have rather strong opinions about some drugs over others, but I can take advices from doctors, physicians, nurses or anyone with a minimum degree of knowledge on the topic. Still, many times I have to argue with with relatives, to the point where I get frustrated.
[+] [-] infinite8s|9 years ago|reply
Edit: It's not clear from the essay, but I'm assuming Patrick's 8% rate is not adjusted for inflation (based on his 40k drawdown scenario - the other 3-4% would cover inflation).
[+] [-] maerF0x0|9 years ago|reply
I simply cannot fathom why he would state that. I cannot imagine a scenario where my retirement income would (nor should) be as high or higher than my peak earning years.
Typically in retirement you have a home and all sorts of hard goods (clothes, furniture, cars) paid off and thus need less money.
[+] [-] wyldfire|9 years ago|reply
Also note that any increased or decreased "need" doesn't factor in to the calculation.
[+] [-] tvanantwerp|9 years ago|reply
[+] [-] jonmb|9 years ago|reply
Your effective tax rate is likely to be much less than your marginal rate.
Also, for anyone interested in financial independence and simple investing with your 401k and IRAs, I'd like to recommend the Stock Series here: http://jlcollinsnh.com/stock-series/
[+] [-] loeg|9 years ago|reply
Me either, unless he assumes:
That's not so unreasonable.[+] [-] tcoppi|9 years ago|reply
[+] [-] infinite8s|9 years ago|reply
[+] [-] arielweisberg|9 years ago|reply
Also an HSA can be used to shelter a bit more income. If you don't consume much health care a HDHP may be the way to go.
There is also the backdoor Roth, but I never wrapped my head around it.
[+] [-] kimsk112|9 years ago|reply
[+] [-] MaulingMonkey|9 years ago|reply
Medical bills.
[+] [-] idunno246|9 years ago|reply
I look at it as diversifying against tax law going crazy though, siNce so much of my retirement income is in 401k and pretax. Also the limits are a third of 401k, so it's only a quarter of retirement savings, and principal can be pulled out if needed.
[+] [-] g52oevr0in|9 years ago|reply
[+] [-] conorgil145|9 years ago|reply
[1]: http://www.mrmoneymustache.com/all-the-posts-since-the-begin...
[+] [-] mholmes680|9 years ago|reply
If nothing else, that site made me realize where i stood on the consumer/producer scale, and what i needed to do to feel better about my future.
[+] [-] charlesdm|9 years ago|reply
[+] [-] misnamed|9 years ago|reply
One handy way to extend your tax-advantaged space: buy Series I and Series EE bonds from Treasury Direct. Both are tax-deferred until you cash them in. You can purchase up to 10K of each type per year. They are government-backed, highly-safe fixed-income instruments.
I bonds will pace inflation (like TIPS) for up to 30 years. EE bonds have low 'normal' yields but they automatically double after 20 years (so around 3.5%/year annualized, better than the rates on 20-year Treasuries). These rates are better than what you get on the open market.
And unlike normal bonds, they won't kick out payments that are taxable along the way - you can save the tax bill until you have a lean year then cash them back out (in the case of I bonds at least), or save them to the end of their lifespan (or until they double in the case of EE bonds).
[+] [-] loeg|9 years ago|reply
[+] [-] torkins|9 years ago|reply
[+] [-] pilingual|9 years ago|reply
https://medium.com/@blakeross/wealthfront-silicon-valley-tec...
https://news.ycombinator.com/item?id=9856151
[+] [-] frinxor|9 years ago|reply
[+] [-] pbreit|9 years ago|reply
2. Max out 401k, IRA
3. Put most of your money in cheap index fund like https://investor.vanguard.com/mutual-funds/lifestrategy/#/
Note: this is not investment advice
[+] [-] jefftk|9 years ago|reply
[+] [-] loeg|9 years ago|reply
[+] [-] ldarcyftw|9 years ago|reply
[+] [-] bbcbasic|9 years ago|reply
In Australia you could pay off your mortgage then refinance in a brand new loan to buy investments. The interest you pay on THAT loan is income tax deductible.
[+] [-] loeg|9 years ago|reply
* https://www.reddit.com/r/personalfinance/wiki/commontopics ("I have $X, what do I do with it?") (and the rest of the PF wiki is a good general resource as well)
* https://www.reddit.com/r/financialindependence/ (How do I save enough to be able to stop working?)
* https://www.bogleheads.org/
[+] [-] rcpt|9 years ago|reply
[+] [-] Ecio78|9 years ago|reply
[+] [-] EGreg|9 years ago|reply
I explain to them that I put most of the money I make into my company, and have a greater ROI than if I put the money into real estate. But, since I have to live somewhere, I rent.
Yet, I am not sure this argument is correct. If I had money for a down payment, perhaps the strategy of getting a mortgage would win in the long run. So, instead of getting into the details, I usually mention I also like to be able to change apartments every year or so.
What are your thoughts - those of you who have now, or have had, growing startups?
[+] [-] MarlonPro|9 years ago|reply
VTSMX 60% VGTSX 30% VBMFX 10%
or ETF's
VTI 60% VXUS 30% BND 10%
These allocations follow the Boglehead principle of 3-Fund portfolio / Lazy portfolio
[+] [-] dennisgorelik|9 years ago|reply
[+] [-] tominous|9 years ago|reply
Money: Set up life insurance, income protection insurance, and decent medical coverage.
Accommodation: You don't need to own your own home, but have some money available to cover rent or mortgage if needed.
Social: Don't let your social life revolve exclusively around work colleagues. Invest time in family and broader groups. Find a way to have achievements outside of work.
So this happened to me. My wife and I went from a very comfortable double income to countless hospital visits and no time or energy for anything else. And this is just after we had kids.
I'll be forever grateful that my wife set up the safeguards above. I was 100% invested in work, financially and socially, so it has been a huge shock and could have been much worse.
[+] [-] orestis|9 years ago|reply
Local banks usually offer a very small selection of funds and the fees are usually 2%, which has a huge impact.
[+] [-] Analemma_|9 years ago|reply
[+] [-] runamok|9 years ago|reply