EmergDoc's Investing Plan Thread [White Coat Investor]

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

EmergDoc's Investing Plan Thread [White Coat Investor]

Post by White Coat Investor » Mon Feb 28, 2011 6:48 pm

When I find myself repeating the same advice over and over I like to put a comprehensive post together that I can link to later to save myself the typing. Examples include past threads on the savings rate, military investing, how to get rich etc.

This one is my response to the frequent poster who posts a question such as “I have $50K saved up and I need to know which funds to put it in!”

My response is: You need an investing plan. I don’t care if you write it down into a formal Investing Policy Statement (see the wiki http://www.bogleheads.org/wiki/Investme ... _Statement), although I think that’s a useful step, but at a bare minimum you need it in your head. Here’s how you make an investing plan. Once you have that, you’ll never have to wonder “What funds should I put this money in?”

How do you make an investing plan?

Step 1 is to formulate your goals. Be as specific as possible, realizing that you’ll make changes as the years go by. Examples of good goals include:

I want $40,000 for home downpayment by June 30, 2013.

I want to have enough money to pay the tuition at my alma mater in 13 years when my 5 year old turns 18.

I want to have $2 Million saved for retirement by Jan 1 2030.

Any goal is better than no goal, but the more specific and the more accurate you can be, the better.

Step 2 is to set up a plan for each goal. The plan consists of identifying what type of account you will use to save the money, choosing the amount you will put toward the goal each year, working out an asset allocation likely to reach the goal with the minimum risk necessary, and identifying a plan B for the goal in case the returns you’re planning on don’t materialize. Let’s look at each of the goals identified in turn and make a plan to reach them.

First, the goal to save up a downpayment.

2A-Choose the type of account. In this case, the best option is a taxable account since it will be relatively short term savings and you don’t want to pay a penalty to take the money out to spend it. A Roth IRA may also be a good option for a house downpayment.

2B- Choose how much to save. When you get to this step it is a good idea to get familiar with the FV formula in excel. FV stands for future value. There are basically 4 inputs to the formula-how much you have now, how many years until you need the money, how much you will save each year, and rate of return. Playing around with these values for a few minutes is an instructive exercise. Also, knowing what reasonable rates of return are can help. If you put in a rate of return that is far too high (such as 15%) you’ll end up undersaving. Since you need this money in just 2 ½ years you’re not going to want to take much risk, so you might only want to bank on a relatively low rate of return and plan to make up the difference by saving more. You decide to save $1400 a month for 28 months to reach your goal. According to excel, this will require a 1.8% return.

2C- Determine an asset allocation. This is likely the hardest stage of the process. Reading some Bogleheadish books such as Ferri’s All About Asset Allocation or Bernstein’s 4 Pillars of Investing can be very helpful in doing this. In this case, you need a relatively low rate of return. The first question is can I get this return with a guaranteed instrument…i.e. take no risk at all. Usually you should look at CDs, money market funds, bank accounts etc to answer this question. MMFs are paying 0.1%, bank accounts up to 1.2% or so, 2 year CDs up to 1.5%, so the answer is that in general, no, you can’t. One exception at this particularly unique time is a high-interest checking account. By agreeing to do a certain number of debits a month, you can get a rate up to 3-4% on up to $25K. So that may work for a large portion of the money. In fact, you could just open two accounts and get your needed return with no risk at all. A more traditional solution would require you to estimate expected returns. Something like 0% real (after-inflation) for cash, 1-3% real for bonds, and 3-6% real for stocks is reasonable. Mix and match to get your needed return.

2D- Lastly, you need a plan in case you don’t get the returns you are counting on, a “Plan B” of sorts. In this case, your plan B may be to either buy a less expensive house, borrow more money, make offers that require the seller to pay more of your closing costs, or wait longer to buy.
Let’s repeat the exercise for the second goal, saving for college.

Goal- 4 years tuition at the Alma Mater beginning in 13 years. Let’s say current tuition is $10K a year. You estimate it to increase at 5%/year. So 13 years from now, tuition should be $19,000 a year, or $76K. Note that you can either do this in nominal (before-inflation) figures or in real (after-inflation) figures, but you have to be consistent throughout the equation.

Vehicle: You wisely select your state’s excellent low cost 529 plan which also gives you a nice tax break on your state taxes.

Savings amount: Using the FV function again, you note that a 7% return for 13 years will require a savings of $4000 per year.

Asset Allocation: You expect 3% inflation, 5% real so 8% total out of stocks and 2% real, 5% total out of bonds. You figure a mix of 67% stocks and 33% bonds is likely to reach your goal. Since your Plan B for this goal is quite flexible (have junior get loans, pay for part out of then current earnings, or go to a cheaper school,) you figure you can take on a little more risk and you go with a 70/30 portfolio.

Plan B: Have junior get loans or choose a cheaper college.

Let’s attack the third goal, admittedly more complicated. You figure you’ll need your portfolio to provide $80K a year (in today's dollars) for you to have the retirement of your dreams. Using the 4% withdrawal rule of thumb, you figure this means you need to have portfolio of about $2 Million (in today's dollars) on the day you retire, which you are planning for January 1st 2030 (remember it is important to be specific, not necessarily right about stuff like this-you can adjust as you go along.) You have $200K saved so far. So using the FV function, you see that you have a couple of different options to reach that goal in 19 years. You can either earn an 5% REAL return and save $49,000 a year (in today's dollars), or you can earn a 3% REAL return and save $66,000 a year (again, in today's dollars). Remember there are only three variables you can change-return, amount saved per year, and years until retirement. Fix any two of them and it will dictate what the third will need to be to reach the goal.

Goal-$2 Million portfolio on Jan 1 2030

Vehicle: Roth IRAs, 401K, taxable account

Savings amount: $49000/year

Asset Allocation: After much reading and reflection on your own risk tolerance and need, willingness, and ability to take risk, you settle on a relatively simple asset allocation that you think is likely to produce a long-term 5% real return:
35% US Stock Market
20% International Stock Market
20% Small Stocks
25% US Bonds

Plan B: Work longer or if prevented from doing so, spend less in retirement

You have now completed step 2, setting up a plan for each goal. Step 3 is relatively simple at this point.

Step 3 is to select the best (usually lowest cost) investments to fulfill your desired asset allocation. Using all or mostly index funds further simplifies the process. Let’s take the retirement portfolio. You have $200K in Roth IRAs and plan to put $5K a year into your IRA and your spouse’s IRA each year through the back-door Roth option. You also plan to put $16.5K into your 401K each year. Unless your spouse also has a 401K, you're going to need to use a taxable account as well to save $49K a year. Your 401K has a reasonably inexpensive S&P 500 index fund which you will use as your main holding for the US stock market. It also has a decent PIMCO actively managed bond fund you can use for your bonds. You’ll use the Roth IRAs for the international and small stocks. So in year one, the portfolio might look like this:

His Roth IRA 40%
25% Total Stock Market Index Fund
20% Total International Stock Market Index Fund

Her Roth IRA 45%
20% Vanguard Small Cap Index Fund
25% Vanguard Total Bond Market Fund

His 401K 5%
5% S&P 500 Index Fund

His Taxable account 5%
5% Vanguard Total Stock Market Index Fund

As the years go by, the 401K and the taxable account will make up larger and larger portions of the portfolio, necessitating a few minor changes every few years.

After this, all you need to do to maintain the plan is monitor your return and savings amount each year, rebalance the portfolio back to your desired asset allocation (which may change gradually as you get closer to the goal and decide to take less risk), and stay the course through the inevitable bear markets and scary economic times you will undoubtedly pass through.

Let’s do one more example, just to help things sink in. Joe is of more modest means than the guy in the last example. He works a blue-collar job and can really only save about $10K a year. He would like to retire as soon as possible, but he admits it was hard to watch his 90% stock portfolio dip and dive in the last bear market, so he isn’t really keen on taking that much risk again. In fact, if he had to do it all over again, he’d prefer a 50/50 portfolio. He figures he could get 5% real out of his stocks, and 2% real out of his bonds, so he expects a 3.5% real return out of his 50/50 portfolio. He expects social security to make up a decent chunk of his retirement income, so he figures he only needs his portfolio to provide about $30K a year. He wants to know how long until he can retire. He has a $100K portfolio now thanks to some savings and a small inheritance.

Goal: A portfolio that provides $30K in today’s dollars. $30K/.04=$750K

Type of account: He has no 401K, so he plans to use a Roth IRA and a SEP-IRA since he is self-employed.

Savings amount: He is limited to $10K a year by his wife’s insistence that the kids eat every day.

Asset allocation: He likes to keep it simple, so he’s going to do:
30% US Stocks
20% Intl Stocks
25% TIPS
25% Nominal bonds

He expects 3.5% real out of this portfolio. Accordingly, he expects he can retire in about 29 years. =FV(3.5%,29,-10000,-100000)=$760,295

Plan B: His wife will go back to work after the kids graduate if they don’t seem to be on track

Investments:

Year 1

Roth IRA 30%
VG TIPS Fund 25%
TBM 5%

Taxable account 65%
TSM 30%
TISM 20%
TBM 20% (he’s in a low tax bracket)

SEP-IRA 5%
VG TIPS Fund 5%


So now we get back to the hypothetical OP’s question. “I have $50K that I need to invest. Where should I put it?” The first consideration is why haven’t you invested it yet? You should be investing the money as you make it according to your plan. If it is a windfall, and you’ve already maxed out your Roth IRAs and 401Ks for the year, you can either use it toward your retirement goal, investing it in a different type of account (such as a taxable account) but still toward your asset allocation for that goal, or you can put it toward a different goal such college savings, paying down the mortgage etc. Alternatively, you could spend it or even give it away to charity.

A few last words about developing an investment plan:

If you fail to plan, you plan to fail.

Any plan is better than no plan.

The enemy of a good plan is the dream of a perfect plan.

There are no old, bold [investors].


Good luck investing.



Edited to incorporate several useful suggestions mentioned lower in the thread
Last edited by White Coat Investor on Wed Mar 02, 2011 11:44 am, edited 6 times in total.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
LadyGeek
Site Admin
Posts: 57457
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Post by LadyGeek » Mon Feb 28, 2011 7:51 pm

This could go as a personal investment advice FAQ into the wiki, similar to the Investing FAQ for the Bogleheads Forum. The bottom of the page lists the others. It's easy enough to add more.
Last edited by LadyGeek on Mon Feb 28, 2011 7:53 pm, edited 1 time in total.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

dbr
Posts: 30629
Joined: Sun Mar 04, 2007 9:50 am

Post by dbr » Mon Feb 28, 2011 7:52 pm

That's pretty good stuff, but the question arises why there seems to be such a constant need for this when two stickies were created to talk about investment planning and asking portfolio advice.

The format of a forum tends to hide the idea that this site is really about education, but the explicit links to same are pretty much nowhere to be found. Well, actually that little square with the "W" in it called Wiki is pretty easy to see, but apparently there is some sort of prohibition operating that sends people to oblivion if they actually click on the button. There is even a whole category of the forum called reference library and Wiki, but maybe that word "reference" attached to library means that is supposed to be the last place to go rather than the first. There are an awful lot of threads where the best suggestion that can be offered is to go read a couple of those good books.

We even had a recent thread about where "Getting Started" is to be found. Another conversation that came up was the issue of supplying a reference list of advisors that can be trusted/appropriate for people, but that one might be opening a can of worms.

Just thoughts.

User avatar
Kilroy
Posts: 23
Joined: Mon Feb 28, 2011 3:10 am

Post by Kilroy » Mon Feb 28, 2011 8:05 pm

EmergDoc,

Thank you so much for this post. I'll admit that I'm one of those posters (if not the poster) who asked the question of how to invest a lump of cash I've saved.

This is a great post and one that is coherently written with great examples. I really appreciate all the people who post regularly on this forum and help to educate and inform those who are willing to learn.

User avatar
Jake46
Posts: 748
Joined: Tue Feb 20, 2007 10:16 am
Location: Fort Collins, Colorado

Post by Jake46 » Mon Feb 28, 2011 8:08 pm

EmergDoc,

Thank you so much for this thoughtful post.

User avatar
Taylor Larimore
Advisory Board
Posts: 28759
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

The First Step

Post by Taylor Larimore » Mon Feb 28, 2011 8:11 pm

Hi Doc:

Your post is a winner!
"Simplicity is the master key to financial success." -- Jack Bogle

User avatar
CaliJim
Posts: 3050
Joined: Sun Feb 28, 2010 8:47 pm
Location: California, near the beach

Post by CaliJim » Mon Feb 28, 2011 8:34 pm

..
Last edited by CaliJim on Thu Jun 02, 2011 11:32 pm, edited 1 time in total.
-calijim- | | For more info, click this Wiki

User avatar
LadyGeek
Site Admin
Posts: 57457
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Post by LadyGeek » Mon Feb 28, 2011 9:08 pm

CaliJim wrote:Good post. I like how you included specific examples. This makes it very concrete for the newbie. Thanks doc.
Other resources:

BH Wiki: http://www.bogleheads.org/wiki/Investme ... _Statement

Dale's Outline: http://www.bogleheads.org/forum/viewtop ... 864#854864

Morningstar Portfolio 101 on Creating the Plan
http://news.morningstar.com/classroom2/ ... &CN=sample

Morningstar Article: http://news.morningstar.com/articlenet/ ... 6&_QSBPA=Y

Good Examples: http://www.bogleheads.org/forum/viewtop ... 539#852539
http://www.bogleheads.org/forum/viewtop ... 327#852327
http://www.bogleheads.org/wiki/IPS#Real-World_IPS
Most of those links were already in the wiki. I just added the Good Examples; now everything's covered - including this thread.

Wiki article link: Investment Policy Statement (Look towards the bottom of the page.)
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

User avatar
CaliJim
Posts: 3050
Joined: Sun Feb 28, 2010 8:47 pm
Location: California, near the beach

Post by CaliJim » Mon Feb 28, 2011 10:09 pm

..
Last edited by CaliJim on Thu Jun 02, 2011 11:32 pm, edited 1 time in total.
-calijim- | | For more info, click this Wiki

nimo956
Posts: 764
Joined: Mon Feb 15, 2010 6:07 pm

Post by nimo956 » Mon Feb 28, 2011 11:45 pm

Thanks for the post. They are always very informative and useful. I especially like the FV function in Excel! It tells me that with a current portfolio of $65k, if I continue to contribute $15k per year for the next 40 years, I will have $50 billion. My only question now is, does anyone know what asset allocation will give me a 33% annual return every year for the next 40 years?

User avatar
bobcat2
Posts: 5359
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Underwhelmed

Post by bobcat2 » Tue Mar 01, 2011 12:00 am

Hi EmergDoc,

I am unimpressed by your investment plans. I am particularly unimpressed by your retirement plan.

You state that the goal of your retirement plan is to have $80,000/year in retirement income starting in 19 years. But this planning seems to have been done on a nominal basis. If inflation were to average only 4% per year the real annual income from your $2 million nominal portfolio in 19 years, assuming a 4% SWR, would be only $38,000 in today's dollars. A far cry from $80,000 in today's dollars. Certainly it can't be the case that you are planning for $80,000 per year in nominal income in retirement regardless of whether its purchasing power in today's dollars is $50,000, $38,000 or $26,000. :roll:

Historically since 1900 inflation has averaged about 3.3% per year. Plugging the historical inflation rate into the calculations means the real returns from the portfolio would be 4.7% and 2.7%, not 8.0% and 5.0%. Using those real returns as the basis of our TVM calculations means our investor needs to save $51,300 per year or $68,300 per year to reach a $2 million portfolio in real terms in 19 years and $80,000 in income per year in today's dollars in retirement. I wish our investor good luck and Godspeed with those annual average savings amounts over the next 19 years. :lol:

A more realistic approach to retirement planning would be to decide you want your living standard in retirement to be no lower than your current living standard. Then make an estimate of how much retirement income that will require in constant dollars, make a reasonable estimate of what your SS income will be in retirement, make an estimate of any DB pension income you will receive in retirement, and see how much you have to save on average per year at say 3% real to bridge the retirement income gap between SS and DB pension income and your target retirement income. If that savings rate is too high your choices basically boil down to working longer, accepting a somewhat lower living standard in retirement than you planned, or increasing investment risk, and taking a chance of lowering your retirement living standard further if the investment risk manifests itself.

You write.
After this, all you need to do to maintain the plan is monitor your return and savings amount each year, rebalance the portfolio back to your desired asset allocation (which may change gradually as you get closer to the goal and decide to take less risk), and stay the course through the inevitable bear markets and scary economic times you will undoubtedly pass through.
For the eleven plus year period since the end of 1999 thru February of 2011 (today) the real return on the US stock market has been negative. I estimate that for the 10 year period 2000-2009 your portfolio would have generated a real return of about 1%, give or take half a percent. What happens if a ten year period between now and 2030 produces results like this or worse to our investor using your plan? While all the while she is saving and investing assuming a near 5% real return. She has taken risk and the risk has happened. If she lowers the risk at that point she will be locking in really low retirement income. If she increases risk and the risk keeps coming , she will end up in retirement in even worse shape than the bad shape she is in at that point. :cry:

Turning to saving and investing so Jr. can attend your Alma Mater. Why wouldn't one at least consider saving and investing at least partially in a pre-paid tuition plan at good ole Alma Mater U and thereby take the guesswork out of college inflation rates as well as portfolio return rates?

BobK

PS - And if anyone is planning on SS not being around in 19 years, then to be consistent you also need to plan on Medicare also not being around in 19 years, since it is in much worse shape than SS. Keep in mind that someone retiring in 19 years and then planning to live in retirement for thirty years will probably get more dollar benefits from Medicare in retirement than from SS. Yes, medical costs are rising that fast. So no Medicare means for most people adding 5%-8% to their savings rate just to keep paddling in place.
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

dailybagel
Posts: 494
Joined: Tue Feb 15, 2011 8:35 pm

Re: Underwhelmed

Post by dailybagel » Tue Mar 01, 2011 12:15 am

bobcat2 wrote: Historically since 1900 inflation has averaged about 3.3% per year. Plugging the historical inflation rate into the calculations means the real returns from the portfolio would be 4.7% and 2.7%, not 8.0% and 5.0%.
EmergDoc wrote: Something like 0% real (after-inflation) for cash, 1-3% real for bonds, and 3-6% real for stocks is reasonable. Mix and match to get your needed return.
Looks like you two are on the same page in spirit, if not in every example calculation.

User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Underwhelmed

Post by White Coat Investor » Tue Mar 01, 2011 12:24 am

bobcat2 wrote:Hi EmergDoc,

I am unimpressed by your investment plans. I am particularly unimpressed by your retirement plan.

You state that the goal of your retirement plan is to have $80,000/year in retirement income starting in 19 years. But this planning seems to have been done on a nominal basis. If inflation were to average only 4% per year the real annual income from your $2 million nominal portfolio in 19 years, assuming a 4% SWR, would be only $38,000 in today's dollars. A far cry from $80,000 in today's dollars. Certainly it can't be the case that you are planning for $80,000 per year in nominal income in retirement regardless of whether its purchasing power in today's dollars is $50,000, $38,000 or $26,000. :roll:
You can do the planning with real numbers too if you like. For example, if your goal is $80K in today's dollars, simply use 5% instead of 8%, that'll tell you how much you need to save (actually, if you want to get picky, you'll need a little more since varying returns have a significant impact.) I calculate out $50K a year needs to be saved under those particular circumstances.

The examples (obviously I felt, but apparently not) weren't intended as some comprehensive retirement plan. They are a way for a newbie to begin to put a framework on his retirement plan rather than collecting funds like they were baseball cards.
For the eleven plus year period since the end of 1999 thru February of 2011 (today) the real return on the US stock market has been negative. I estimate that for the 10 year period 2000-2009 your portfolio would have generated a real return of about 1%, give or take half a percent. What happens if a ten year period between now and 2030 produces results like this or worse to our investor using your plan? While all the while she is saving and investing assuming a near 5% real return. She has taken risk and the risk has happened. If she lowers the risk at that point she will be locking in really low retirement income. If she increases risk and the risk keeps coming , she will end up in retirement in even worse shape than the bad shape she is in at that point.
Ideally you stay the course and return to the mean occurs in the next decade and you end up in even better shape since you "bought low." A retirement investor is investing over a period of 50 or 60 years most of the time. But obviously dispersion of returns is very important. Low returns in the last decade before retirement and the first decade of retirement can really do some damage to any portfolio. And if the returns you are planning on don't materialize, then you go to plan B-spend less in retirement or work longer.

But just because these issues can and do come up doesn't mean a new investor shouldn't develop a plan.

And pre-paid tuition is a great idea. My alma mater doesn't have one, but apparently yours does.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

stan1
Posts: 7594
Joined: Mon Oct 08, 2007 4:35 pm

Post by stan1 » Tue Mar 01, 2011 12:32 am

Another vote for examples, especially when they are non-trivial and relevant. People learn and visualize differently. Some people will get more out of this post than reading 4 Ferri books plus 4 Swedroe books. Thanks ED.

User avatar
bobcat2
Posts: 5359
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Post by bobcat2 » Tue Mar 01, 2011 12:40 am

dailybagel writes.
Looks like you two are on the same page in spirit, if not in every example calculation.
In spirit we are not only not on the same page, I don't think we are in the same book.

EmergDoc says plan on having $80,000 in nominal income per year in retirement. I say target a constant purchasing power or real level of income in retirement. Under EmergDoc's plan we have no idea what the purchasing power of $80,000 nominal will be in 19 years. It could be $70,000 in today's purchasing power, or $50,000, or $35,000, or $25,000 because we don't know what inflation will be over the next 19 years.

I am targeting a constant purchasing power or real income per year target in retirement. In other words if my target is $50,000 real income per year in retirement, then every year in retirement my target income will be the equivalent of the purchasing power of $50,000 in income this year.

To repeat EmergDoc is targeting nominal income in retirement and I am targeting real (inflation-adjusted) income in retirement. Because we don't know what inflation will be over the next 19 years, we have no idea what retirement standard of living EmergDoc's nominal targeted income will support. We have a very good idea of what retirement standard of living my real targeted income will support.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Post by White Coat Investor » Tue Mar 01, 2011 1:53 am

bobcat2 wrote:dailybagel writes.
Looks like you two are on the same page in spirit, if not in every example calculation.
In spirit we are not only not on the same page, I don't think we are in the same book.

EmergDoc says plan on having $80,000 in nominal income per year in retirement. I say target a constant purchasing power or real level of income in retirement. Under EmergDoc's plan we have no idea what the purchasing power of $80,000 nominal will be in 19 years. It could be $70,000 in today's purchasing power, or $50,000, or $35,000, or $25,000 because we don't know what inflation will be over the next 19 years.

I am targeting a constant purchasing power or real income per year target in retirement. In other words if my target is $50,000 real income per year in retirement, then every year in retirement my target income will be the equivalent of the purchasing power of $50,000 in income this year.

To repeat EmergDoc is targeting nominal income in retirement and I am targeting real (inflation-adjusted) income in retirement. Because we don't know what inflation will be over the next 19 years, we have no idea what retirement standard of living EmergDoc's nominal targeted income will support. We have a very good idea of what retirement standard of living my real targeted income will support.

BobK
Your points are valid (and in fact my own retirement plan specifies my desired income in 2006 dollars-the year I made my plan- and I use expected real returns). But they are also above the level I was aiming at. For an advanced discussion on the topic, I refer the reader to the Bogleheads Book on Retirement Planning and the FIRE calculator.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
CaliJim
Posts: 3050
Joined: Sun Feb 28, 2010 8:47 pm
Location: California, near the beach

Post by CaliJim » Tue Mar 01, 2011 2:19 am

..
Last edited by CaliJim on Thu Jun 02, 2011 11:31 pm, edited 1 time in total.
-calijim- | | For more info, click this Wiki

User avatar
CaliJim
Posts: 3050
Joined: Sun Feb 28, 2010 8:47 pm
Location: California, near the beach

Post by CaliJim » Tue Mar 01, 2011 2:26 am

..
Last edited by CaliJim on Thu Jun 02, 2011 11:30 pm, edited 1 time in total.
-calijim- | | For more info, click this Wiki

User avatar
OnFire
Posts: 362
Joined: Sat Feb 16, 2008 11:48 pm

Post by OnFire » Tue Mar 01, 2011 2:33 am

Bobcat2,

If one has been a Boglehead for two or three years and reads the forum on a weekly basis or better, they will gain a certain financial knowledge. EmergDoc's post is to assist people who have the equivalent of a 6th grade financial education to get up to doing high school work.

You, I, and EmergDoc have ready completed the equivalent of our college level financial education. We have read the books, done the studies, and implemented our plans. I believe you and the Doc are finishing up your Masters.

I believe that you aren't understanding ERDoc's point. If the people who stumble across this site knew the difference between real, nominal, and inflation adjusted dollars, they wouldn't be asking questions like, "I have $50,000, what should I do with it?". I can almost guarantee they don't know what a SWR is. In short, you are way above the level of the people who come here for beginners help. ERDoc has done something extremely helpful and useful fo the new investor.

You have not.

OnFire.
Where are all the customers yachts? | | “The most powerful force in the Universe is compound interest.” -Albert Einstein

User avatar
bobcat2
Posts: 5359
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Post by bobcat2 » Tue Mar 01, 2011 1:39 pm

Hi OnFire,
Everything should be made as simple as possible, but not one bit simpler.
- Albert Einstein

EmergDoc's advice violates this fundamental rule because his advice is simplistic and wrong. Giving bad advice because it is simple does not make it good advice. Retirement goals should be stated in terms of your living standard (or spending) in the future relative to your living standard (or spending) today. These spending goals should be in terms of constant purchasing power - so your future spending buys the same amount of stuff as your spending today buys. Apparently unlike you, I think most people can understand that.

OTOH Emergdoc's preferred retirement goal, which is in terms of nominal income, is equivalent to the following. A company enters into a contract to buy 100,000 tons of a raw material from a seller at a fixed price per ton over the next 12 months. But the contract doesn't specify what constitutes a ton of the raw material. I think most people can also understand the inherent flaw in approaching financial problems from this point of view.

You wrote.
If the people who stumble across this site knew the difference between real, nominal, and inflation adjusted dollars, they wouldn't be asking questions like, "I have $50,000, what should I do with it?". I can almost guarantee they don't know what a SWR is.
I didn't bring up real returns or the SWR, EmergDoc brought up both initially.
EmergDoc quote.
Asset Allocation: You expect 3% inflation, 5% real so 8% total out of stocks and 2% real, 5% total out of bonds. ...

Using the 4% withdrawal rule...
That withdrawal rule EmergDoc talks about is the standard SWR, is it not? So if your point is I should have said "4% withdrawal rule" instead of 4% SWR, then I plead guilty. :)

Finally, here's some words of wisdom from Yogi on why you should use real dollars rather than nominal dollars when doing retirement planning.

"A nickel ain't worth a dime anymore." - Yogi Berra. :wink:

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

User avatar
LadyGeek
Site Admin
Posts: 57457
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Post by LadyGeek » Tue Mar 01, 2011 9:01 pm

A few words about approximating financial data when using spreadsheet functions, e.g. FV(). The underlying financial equations are exponential. Small differences in approximations can result in large errors. Using EmergDoc's examples:

Goal 2B - I want $40,000 for home downpayment by June 30, 2013. You decide to save $1400 a month for 28 months to reach your goal. According to excel, this will require a 3% return.

With FV() and assuming that 3% was "close enough" gives:

$40,552 =FV(3%/12,28,-1400)

However, RATE() solves for this exactly:

1.79% (nominal) =RATE(28,-1400,0,40000)*12
1.80% APY =EFFECT(1.79%,12)

The difference between the assumption and an exact solution is 1.2%.
===========

Goal- 4 years tuition at the Alma Mater beginning in 13 years... tuition should be $19,000 a year, or $76K. Savings amount: Using the FV function again, you note that a 7% return for 13 years will require a savings of $4000 per year.

$80,562 =FV(7%,13,-4000)

$3,773.46 = PMT(7%,13,0,-76000)

That's a difference of $226.54 /year.
-or-
You can use FV() with Excel's (or Open Office) goal seek and solve for the unknown variable.

D7 = $3,773.46
$76,000.00 = =FV(0.07;13;-D7) <-- done in Open Office
========================
Take a look in the wiki article: Comparing Investments. Focus on Cash flow diagrams, Sign convention, and Financial variables. With those concepts, you can solve anything. Just be sure to setup the problem correctly. Note the sign conventions used in the above examples.

However, many people have problems using anything much more than simple math, even if it's in a spreadsheet. If someone wants to learn this, that's great. If not, they'll use online calculators or software that does this for them.

The idea is to make the concepts as simple as possible, but with a strong understanding of where the limits are.

(I asked EmergDoc via PM how the examples were calculated.)
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Post by White Coat Investor » Wed Mar 02, 2011 1:07 am

bobcat2 wrote:

EmergDoc's advice violates this fundamental rule because his advice is simplistic and wrong.
http://xkcd.com/386/

Between Bobcat's fixation on using real numbers and Ladygeek's insistence on more accurate use of excel functions I guess I'll have to edit the OP. I'll try to do it as soon as I get time lest I lead any newbies astray.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

SP-diceman
Posts: 3968
Joined: Sun Oct 05, 2008 9:17 am

Post by SP-diceman » Wed Mar 02, 2011 2:44 am

EmergDoc wrote:
bobcat2 wrote:

EmergDoc's advice violates this fundamental rule because his advice is simplistic and wrong.
http://xkcd.com/386/

Between Bobcat's fixation on using real numbers and Ladygeek's insistence on more accurate use of excel functions I guess I'll have to edit the OP. I'll try to do it as soon as I get time lest I lead any newbies astray.
Who knew life had rounding errors?
Lets see, how long has man been on planet earth?
How long have there been spreadsheets?

hmmmmmmmmm.

User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Post by White Coat Investor » Wed Mar 02, 2011 3:02 am

SP-diceman wrote: Lets see, how long has man been on planet earth?
How long have there been spreadsheets?
About the same length of time, no? :)
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

Oneanddone
Posts: 1549
Joined: Sun Dec 12, 2010 10:39 am

Post by Oneanddone » Wed Mar 02, 2011 6:57 am

Good job, EmergDoc.


Let me make one small suggestion. Change, "I want to have enough money in a 529 to pay the tuition at my alma mater in 13 years when my 5 year old turns 18." Get rid of the phrase "in a 529".

The real goal isn't to have enough money in a 529. The real goal is to have enough money to pay for college in 13 years.

Only after the goal is determined should one worry about the investment vehicle. In short, for this one, you put part of step 2 in step 1.

User avatar
bobcat2
Posts: 5359
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Get Real about Retirement Planning

Post by bobcat2 » Wed Mar 02, 2011 7:58 am

Planning for retirement using nominal values throws financial risk management out the window. It exposes the investor to huge inflation risk in retirement. Developing the retirement plan using real values isn't an additional detail that slightly improves things, it is instead essential for sound retirement planning.

This type of mistake is usually made because a poor retirement goal is selected. The most meaningful retirement goal for nearly everyone is selecting a retirement living standard relative to their current living standard. The most common relationship is planning to maintain the current pre-retirement living standard throughout retirement. But any and all retirement living standard goals must be done on a real basis.

Setting a $80,000 nominal income retirement goal may, if inflation is low for the 19 years between now and retirement, produce the retirement of your dreams. :D Setting a $80,000 nominal income retirement goal may, if inflation is high for the 19 years between now and retirement, produce the retirement of your nightmares. :cry:

BTW EmergDoc, I have a question about the retirement planning example in your post. You write.
You have $200K saved so far. So using the FV function, you see that you have a couple of different options to reach that goal in 19 years. You can either earn an 5% REAL return and save $49,000 a year (in today's dollars), or you can earn a 3% REAL return and save $66,000 a year (again, in today's dollars).
How realistic are these annual savings amounts for 98% of US households :?: Keeping in mind that median household income in the US is less than $50,000. This is a classic example of giving retirement planning advice that makes most people give up on planning for retirement. :lol:

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

pkcrafter
Posts: 13612
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Post by pkcrafter » Wed Mar 02, 2011 9:16 am

Doc, this is a very good and practical post for newbies. Hope it ends up in the Wiki.

While Bobcat is technically correct, we need to consider just who is asking the question. Doc defines this person:
This one is my response to the frequent poster who posts a question such as “I have $50K saved up and I need to know which funds to put it in!”
The person asking the question will not even know what nominal means and to start a newbie off in a first response with an explanation, examples, etc. will probably drive him away. I think by just saying "today's dollars" in there somewhere is quite sufficient. You don't want to throw new concepts and numbers a newbie can't relate to in a first reply. A deeper understanding can come later.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
bobcat2
Posts: 5359
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Post by bobcat2 » Wed Mar 02, 2011 11:24 am

Paul,

You misunderstand the disagreement. Saying today's dollars is fine. EmergDoc's post started out by not being in today's dollars and that was not fine. EmergDoc has since edited his post (in response to my criticism of his using nominal values) to say today's dollars and changing the analysis from nominal values to real values (today's dollars). It makes no difference whether we say today's dollars, or constant dollars, or real dollars, or constant purchasing power, they all mean the same thing. But one of them needs to be said and the analysis needs to be done in a real rather than a nominal framework, however you want to call it. That's because the alternative of using nominal values and not accounting for inflation is bad retirement planning advice, and originally the post's advice was in nominal and not constant dollars.

BTW telling a newbie that she and her hubby need to save $49,000-$63,000 per year will also probably drive her away. Unless of course her name is Lovey and her husband is Thurston Howell, III. :lol:

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Post by White Coat Investor » Wed Mar 02, 2011 11:42 am

bobcat2 wrote: BTW telling a newbie that she and her hubby need to save $49,000-$63,000 per year will also probably drive her away. Unless of course her name is Lovey and her husband is Thurston Howell, III. :lol:

BobK
Unfortunately, that's the reality of it. $80K in income is a pretty lofty goal. Like I said above, there's only a few variables that can be changed-you either save more, work longer, or take more risk (and hope it pays off.) Realizing that, I tried to add another example that would apply to more people. Maybe I ought to change the original example instead.
Last edited by White Coat Investor on Wed Mar 02, 2011 11:48 am, edited 1 time in total.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
Topic Author
White Coat Investor
Posts: 14219
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Post by White Coat Investor » Wed Mar 02, 2011 11:44 am

Oneanddone wrote:Good job, EmergDoc.


Let me make one small suggestion. Change, "I want to have enough money in a 529 to pay the tuition at my alma mater in 13 years when my 5 year old turns 18." Get rid of the phrase "in a 529".

The real goal isn't to have enough money in a 529. The real goal is to have enough money to pay for college in 13 years.

Only after the goal is determined should one worry about the investment vehicle. In short, for this one, you put part of step 2 in step 1.
You're right (like the other critics!)
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
bobcat2
Posts: 5359
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Post by bobcat2 » Wed Mar 02, 2011 12:04 pm

EmergDoc wrote:
bobcat2 wrote: BTW telling a newbie that she and her hubby need to save $49,000-$63,000 per year will also probably drive her away. Unless of course her name is Lovey and her husband is Thurston Howell, III. :lol:

BobK
Unfortunately, that's the reality of it. $80K in income is a pretty lofty goal. Like I said above, there's only a few variables that can be changed-you either save more, work longer, or take more risk (and hope it pays off.) Realizing that, I tried to add another example that would apply to more people. Maybe I ought to change the original example instead?
Yes. The original example should be somewhere in-between the original and the second example, but a hell of a lot closer to the second example and include some mention of SS. :lol:
You might want to start by having their savings 19 years before retirement being a lot more reasonable in relation to their retirement goal than it currently is, and make the portfolio target at retirement between $1 million and $2 million, but closer to $1 million. The one example, like your second example, could incorporate two rather than one AA's. Not everyone should be at 75% equity in their mid to late 40s.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

User avatar
LadyGeek
Site Admin
Posts: 57457
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Post by LadyGeek » Wed Mar 02, 2011 8:28 pm

Is Post #1 ready for the wiki? It probably deserves it's own page.

Goal- 4... a 7% return for 13 years will require a savings of $3,773 per year

The Comparing Investments wiki page now has a blue info box on the right side showing the Excel function needed to solve for any of the financial variables. Also, I clarified the footnotes to explicitly give credit to dratkinson who explained the concepts of cash flow diagram, financial variables, and sign convention to me (the footnotes only mentioned 'from forum member').

(Updated to clarify footnote comments.)
Last edited by LadyGeek on Wed Mar 02, 2011 9:14 pm, edited 1 time in total.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

pkcrafter
Posts: 13612
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
Contact:

Post by pkcrafter » Wed Mar 02, 2011 8:42 pm

Got it, Bob. In the end, it's a very good contribution.


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

User avatar
LadyGeek
Site Admin
Posts: 57457
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Post by LadyGeek » Thu Mar 03, 2011 9:41 pm

I've added an investing plan section to the wiki. It summarizes Post #1, then points back to this thread for the details.

Wiki article link: Investment Policy Statement

Comments / questions / corrections are welcome.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

allsop
Posts: 1046
Joined: Sun Jun 15, 2008 7:08 am

Re: Underwhelmed

Post by allsop » Fri Mar 04, 2011 1:24 pm

EmergDoc wrote:
bobcat2 wrote:Hi EmergDoc,

I am unimpressed by your investment plans. I am particularly unimpressed by your retirement plan.

You state that the goal of your retirement plan is to have $80,000/year in retirement income starting in 19 years. But this planning seems to have been done on a nominal basis. If inflation were to average only 4% per year the real annual income from your $2 million nominal portfolio in 19 years, assuming a 4% SWR, would be only $38,000 in today's dollars. A far cry from $80,000 in today's dollars. Certainly it can't be the case that you are planning for $80,000 per year in nominal income in retirement regardless of whether its purchasing power in today's dollars is $50,000, $38,000 or $26,000. :roll:
You can do the planning with real numbers too if you like. For example, if your goal is $80K in today's dollars, simply use 5% instead of 8%, that'll tell you how much you need to save (actually, if you want to get picky, you'll need a little more since varying returns have a significant impact.) I calculate out $50K a year needs to be saved under those particular circumstances.
After I read Four Pillars I'm only using after-inflation numbers in financial planning, unless the planning is for the short term. Nowadays I don't understand why I didn't do this earlier....

Learning101
Posts: 30
Joined: Sun Sep 16, 2018 8:14 am

Re: EmergDoc's Investing Plan Thread

Post by Learning101 » Sun Mar 24, 2019 9:10 am

Dear Sir,

Thank you for sharing the steps on making an investment plan, sorry to be a wally but please could you provide me a further example of section 2-B using the FV on Excel as I have only just purchased this to calculate how much is needed.

Thank you in advance.

User avatar
WoodSpinner
Posts: 863
Joined: Mon Feb 27, 2017 1:15 pm

Re: EmergDoc's Investing Plan Thread

Post by WoodSpinner » Sun Mar 24, 2019 9:19 am

A quick Google on “Excel FV” will lead to numerous writtenexamples and other videos.

This should be a good start.

https://exceljet.net/excel-functions/excel-fv-function

Learning101
Posts: 30
Joined: Sun Sep 16, 2018 8:14 am

Re: EmergDoc's Investing Plan Thread

Post by Learning101 » Sat Mar 30, 2019 7:56 am

Dear Woodspinner,

Thank you for the swift response and the link.

Regards,

Mark :happy

staythecourse
Posts: 6993
Joined: Mon Jan 03, 2011 9:40 am

Re: EmergDoc's Investing Plan Thread

Post by staythecourse » Sat Mar 30, 2019 8:08 am

Sure this thread will be of use for many.

Just wanted to highlight that as mentioned be specific when coming up with financial goals in relation to dates the money is needed. This will help come up with you asset allocation. A general range I tend to use is:

0-2 years: 100% principle stable
2-4 years: 20% stocks
4-6 years: 40%
6-8 years: 60%
8-10 years: 80%
10+ years: 100%

This doesn't mean you SHOULD be at the max, but shouldn't be pushing it past the recs. This will help set asset allocation for different goals based on time horizon for that goal.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

Learning101
Posts: 30
Joined: Sun Sep 16, 2018 8:14 am

Re: EmergDoc's Investing Plan Thread [White Coat Investor]

Post by Learning101 » Sun Apr 14, 2019 6:32 am

Many thanks

User avatar
LadyGeek
Site Admin
Posts: 57457
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Re: EmergDoc's Investing Plan Thread [White Coat Investor]

Post by LadyGeek » Sat Apr 20, 2019 10:03 am

Learning101 has additional questions which I've moved into a stand-alone thread. See: Personal investment plans
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

Learning101
Posts: 30
Joined: Sun Sep 16, 2018 8:14 am

Re: EmergDoc's Investing Plan Thread [White Coat Investor]

Post by Learning101 » Mon Apr 22, 2019 7:26 am

Sorry posting in the wrong place!

Post Reply