Category Archives: Financial Planning

Financial Planning for New College Graduates

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You did it.  You earned your college degree.  Congratulations on this major life accomplishment.

Hopefully, you have a job lined-up in your field of study.  If not, don’t get overwhelmed.  Start applying and interviewing.   Before you know it, you will be working, growing your career, and earning a paycheck.

The good times are not over, but it is time to enter the real world.  By starting this next chapter of your life on the right track, you will be able to better ensure a sound financial future.  Right now, time is on your side.

As a new college graduate, I am sure the last thing on your mind is retirement.  Retirement might be many decades away, but the actions you take in the coming years will shape your financial future.  Below are the key steps that will help you to establish a plan that will guild you on your journey toward financial independence.

Step 1 – Save 15% of your salary.  Start this process of saving with your first paycheck.  It might sound like a high percentage, but this is just the first step.

Step 2 – Sign up for your employer’s retirement savings plan.  If you work in the for-profit universe, it is called know as a 401K.  If you work at a not-for-profit organization, it is called a 403B.  If you work for the Federal Government, it is a Thrift Savings Plan (TSP).  On your first day of work, go to the Human Resources office and sign up to contribute 15% of your salary to their retirement savings plan.  Increase the amount that you contribute to your retirement plan by 1% every year.

Step 3 – If possible, only Invest using low-cost mutual funds and index funds.  Avoid trying to pick individual stocks or trying to time the market.  Identify an asset allocation that best matches your age and risk tolerance.  Historically stocks have produced higher returns than bonds. Stocks, however, are more volatile.  On the other hand, bonds are less volatile but do not keep up well with inflation.  Establish a plan that uses both stocks for growing your wealth and bonds to retain your wealth during bad economic times.

Step 4 – Establish a plan to pay off your student loan debt.  Don’t fall victim to the mindset of the masses when it comes to student loans.  You attended college and earned a degree.  Hopefully, you paid attention in class and are ready to put your degree to work for you as an employee.  You attended class, possibly lived in a dorm, and most likely ate your meals in the cafeteria.  It is time to pay back what you owe.  Avoid self-pity and feelings of entitlement.  Those ill feelings will just hold you back on many levels.

Step 5 – Get a part-time job.  For those who have the entrepreneurial spirit, start a side business.  You are young and full of energy.  Now is the time for you to be working and building a solid financial foundation.  Getting a part-time job will allow you to earn extra money.  Working a couple of evenings during the week and picking up some hours on the weekend will greatly help to increase your earnings. That extra money can be used to pay off your student loans, establish an emergency fund, or open a Roth IRA.

Step 6 – Put off attending graduate school.  Unless you work in an industry that requires a graduate degree to obtain entry-level employment, put off attending for a couple of years.  Find an employer who offers tuition assistance as part of their compensation package.  That will allow you to work in the day and take graduate classes in the evening or on the weekend.

Step 7 – Write a financial plan.  A financial plan is a map.  It allows you to identify where you are at from a financial standpoint.  A financial plan is also a map that can be used as a guide to where you want to be in the future.  It helps to have a guide than to go it alone.  Financial planning is too important of a topic to not have a plan and just fly by the seat of your pants.  A financial plan is a living document that needs to be reviewed annually.  The great feature of a financial plan is that it can be amended as your plans and goals change.

Step 8 – Establish a budget.  Calculate how much you will earn every month from your job.  Write out your budget based on percentages.  Know how much of your salary will go towards housing, food, entertainment, and every other expense.  Be sure to write a budget that is practical in terms of expenses and prudent in terms of savings. In other words, always try to reduce expenses and to increase savings.

Step 9 – Keep your transportation costs low.  Transportation costs are simply an expense in your budget.  Use your budget as a guide to determine how much you can afford to spend on a car.  Keep your transportation costs at 11% of your budget.  Your budget will determine if you can afford a fancy new car or a used economy model.  Try to keep in mind that a car does not determine your identity.  It is just what enables you to travel from Point A to Point B in a timely manner.

Step 10 – Keep your housing costs as low as possible.  If you are renting, try to find a roommate or two.  Having a few roommates greatly reduces the amount you will have to pay for rent every month.  As you advance in your career and if you have a family, you might consider buying a house.  Use your budget as a guide to determine how much house you can afford.

Step 11 – Be sure that you are properly insured.  If you are under the age of 26, you should be able to remain on your parent’s health insurance.  If not, ask your employer about when you are eligible for coverage under their plan.  You are young and most likely healthy, but one trip to the emergency room could ruin you financially if you do not have proper health insurance.  Also, be sure that you have the proper amount of insurance for your car, home or apartment, and life insurance if you have a spouse or children.

Step 12 – Avoid Debt. Keep your debt to a minimum.  Avoid payday loans and credit card debt at all costs.  Having a high credit score is important because it will allow you to get the most favorable interest rates if you do have to borrow money.  To ensure you do not take on too much debt, monitor your debt with the Debt-To-Income Ratio.  Always try to keep your DTI under 16% and never exceed 36%.  In life, sometimes debt is unavoidable.  Most people will have to take out a mortgage to purchase a house.  Some people will have to take out a car loan in order to have a means of transportation.  When doing so, use both your budget and DTI to determine how much you can safely afford.

Conclusion

There you have it.  You are finished with college and ready to take on the world.  Don’t put off applying these steps.  You can start implementing some of these steps on your first day of employment.  If you start out with a well-established plan, you will be well ahead of your peers.  Use these steps as a guide and you will surely become a financial success story.

Do you agree with these suggestions?  Do you think that anything is missing from this plan?  What would you add or do differently?

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The Roth IRA is 20 Years Old

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The Roth IRA has now been around for 20 years.  Where does the time go?  Time sure does seem to fly when you are having fun.  It seems to go faster when you are dollar-cost-averaging and building wealth.

That is exactly what the Roth IRA has done over the past 20 years.  It has been a great wealth building tool for many individual investors.  Since it was created, I have been depositing money into my Roth IRA in the form of dollar-cost-averaging with almost every paycheck for the past 20 years.

The Roth IRA has come a long way in 20 years.  The Roth IRA is named after William Roth a Senator from the state of Delaware and was part of the Taxpayer Relief Act of 1997.  What makes the Roth IRA different from a Traditional IRA is that unlike the Traditional IRA, there are not any immediate tax deductions.  The Roth IRA is funded with after-tax earnings and when the money is withdrawn at retirement, it is tax-free.

When I first started investing, the Roth IRA was not available.  It did not become available until I was investing for about 1-year.  As soon as I learned about the Roth IRA, it sounded like a great wealth building tool.

When the Roth IRA was first introduced, the annual contribution limits were only $2,000 per year for an individual who qualified. From 1998 until 2001, the contribution limits were $2,000. The contributions limits have slowly been increasing over the past 20 years.  In 2002, people over 50 have been allowed to contribute more in the form of a catch-up contribution as they got closer to retirement age.  In 2018, individual under the age of 50 can contribute $5,500 per year and people who are over age 50 can contribute $6,500 per year.

There are income limits on who can take advantage of the Roth IRA.  Single filers who earn less than $120,000 qualify for a full contribution.  Single filers who earn between $120,000 and $135,000 are eligible for a partial contribution.  Joint filers who earn up to $189,000 can take advantage of the full contribution.  Joint filers who earn between $189,000 and $199,000 are eligible for a partial contribution.

Since my wife and I earn less than $189,000 we are able to better diversify out retirement tax strategy.  We contribute to our Traditional 403B accounts to reduce our annual taxable income. We also contribute to our Roth IRA accounts to have money that can be withdrawn tax-free later on in retirement.

What if you want to contribute to a Roth IRA account, but do not qualify.  For those folks, there is a Backdoor Roth IRA method that could be used to convert a traditional IRA into a Roth.  That approach is more complicated based on taxation.  It might be wise to check with a CPA before trying to implement this strategy.

Unlike a Traditional IRA or 401K, there are not any Required Minimum Distributions (RMDs) with a Roth IRA.  In a Traditional IRA account, the money has to start to be withdrawn at age 70 ½. That is not the case with a Roth IRA.  The money never has to be withdrawn.  It can remain in the Roth IRA and the money can keep growing.

Since the money never has to be withdrawn, it is recommended by many financial professionals to drawdown Roth IRA accounts last.  We have added that strategy to our retirement drawdown plan.  Based on our age and different types of investment accounts, we will be following a Buckets Approach to funding our retirement.

We will first drawdown our taxable accounts.  The second source of retirement income will come from our Traditional IRAs based on the RMD schedule.  If we live long enough, the last source that we plan on drawing down is our Roth IRA accounts.

There are many benefits with passing on a Roth IRA to a surviving spouse.  They are not forced to take RMDs. They can roll the inherited Roth IRA over into their own Roth IRA.  They can also continue to contribute to the Roth IRA with new earnings.  These benefits do not apply to someone who inherits a Roth IRA who is not the spouse.

Another benefit of a Roth IRA is that you can withdraw money from the account prior to being age 59 ½.  With a Traditional IRA, there is a penalty for early withdrawals.  The money that a person withdraws early is taxed as ordinary income.  There is also a 10% penalty unless it is considered a special circumstance.  With a Roth IRA, there are not any penalties if the money that is taken out is limited to contributions.

Over the past 20 years, the Roth IRA has become a very popular type of retirement account.  According to the Employee Benefit Research Institute, more than 29% of all individuals have a Roth IRA account.  That is an amazing statistic since so many Americans struggle with saving money for retirement.

There are few things in life that most people agree on.  In the world of personal finance, I cannot think of anyone in the financial independence community who does not like the benefits of investing in a Roth IRA account.  It is hard to not see and embrace the ability to build wealth in an account that allows people to have tax-free income at retirement.

Do you invest in a Roth IRA account?

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The Rule of 72

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Do you want to know how long it will take to double your money?  Most investors do.  Are you interested in the expediential growth of your money?  Have you ever tried to calculate the rule of 72?

When I first started to read personal finance and investing books, I learned about the math behind what makes investing work.  The big driver behind what causes your money to grow is compound interest. While I was studying, the one theory that I kept coming across was the rule of 72.

The rule of 72 is just a basic mathematical formula.  It is used as a tool to help investors determine when they should expect to double the money they currently have invested.  The rule of 72 allows an investor to know when they should expect to double their money based on a forecasted rate of return.

Start by taking the projected rate that you expect your investment to return every year.  Divide that interest rate by 72. That will give you the number of years that it will take for you to double your money.

Example:

72 / 6% expected rate of return = 12 years to double your principal

72 / 8% expected rate of return = 9 years to double your principal

72 / 10% expected rate of return = 7.2 years to double your principal

The rule of 72 is what makes stocks a more attractive option than bonds or other fixed-income investments.  For example, the Vanguard 500 (VFINX) has returned 10.97% per year between the years 1976 and 2016.  Currently, the average interest rate on an FDIC insured savings account is slightly higher than1.15%. What is the difference between these two investments based on the rule of 72:

Vanguard 500 – 72 / 10.97 = 6.56 years to double your principal

Saving account (national average) – 72 / 1.15 = 62 years to double your principal

Over the coming decade, stocks are not expected to return 10% per year.  Currently, stocks are expensive investments and there is not much value to be found.  Jack Bogle who founded Vanguard and the first S&P 500 index fund that was available to individual investors predicts a more modest return of 6 or 7 percent for the coming decade.  Based on that forecast and the rule of 72, how long would it take to double an investment of $3K in the Vanguard S&P 500 fund:

Vanguard 500 – 72 / 6.5% = 11 years to double your principal

Time is on Your Side

When I started investing, I received a brochure from the investment company that provided me with a few charts on compound interest.  The chart showed how the rule of 72 worked with different interest rates. The brochure explained the wealth-building power of stocks vs more conservative investments based on the difference in long-term performance.  It also showed how it benefited an investor who had a few decades to take advantage of this powerful wealth building formula.

For example, a one-time investment of $10K to grow in value to $40K based on different interest rates:

  • If an investor received a return of 3%, it would take 48 years for that $10K to grow to $40K
  • If an investor received a return of 6%, the time would be reduced to 24 years to grow to $40K
  • If an investor received 12%, however, it would only take 12 years to grow $10K to $40K

What to do Now

What can investors do now to follow the rule of 72?  What are some alternatives since the S&P 500 is projected to underperform its historical average?  Is it possible to try to reduce the time it takes to double your money without taking on too much risk?  Here are some options that might help in doubling your money quicker:

Save more money.  By increasing your savings, you will double your money at a faster pace.  Try to increase your savings by 2-3% per year.

Go beyond the S&P 500.  Add a small-cap blend or extended market index fund that includes mid-cap stocks to your asset allocation.  Small-cap stocks have historically outperformed large-cap stocks. If you go with a 4:1 Ratio, you will emulate the total stock market.

Go beyond the United States for investing opportunities.  Add some international stocks to your portfolio. Add both developed nations and emerging markets for their growth potential.

Remember to keep some bonds in your portfolio.  Many experts are telling investors to stay away from bonds because of their current low yield and the raising interest rates.  Bonds have an opposite correlation than stocks. When stocks go down in value, bonds go up. By owning some bonds, you can buy stocks at a lower price when there is a stock market correction.

Conclusion  

As an investor, you should keep the rule of 72 in the front of your mind.  You do not need to know the exact date as to when you will double your money.  From time-to-time, look at how your portfolio performed over the past 5 or 10 years to identify what your average rate of return is.  Apply the rule of 72 to know where you stand. If you are not satisfied with how long it is taking, look for ways to increase your returns that are within your risk tolerance.   

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Defining Your Investment Style

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There are many different approaches an investor can take in managing their money.  Some approaches are hands-off and require little effort to maintain the desired asset allocation.  Other approaches are more time intensive and might require daily or weekly management.  There are other approaches that fall somewhere in-between.

No matter how you decide to invest, you need to have an investment philosophy.  It should be part of your financial plan.  Without having direction, there is just too much noise to misdirect you on a daily basis.  Every hot investment tip will sound like a good idea.  That will lead an investor to try to chase performance.

It is up to you to decide how you want to invest your money.  Some approaches are considered more favorable than others because they are tax efficient, cost very little, and allow investors to capture average market returns.  There are approaches that rely on investment professionals to try to beat the market.  Some investors feel confident that they can manage their own selection of individual securities and want to pick their own stocks.  There are also Robo-Advisors that investors can use to manage their investments.

When it comes to trying to invest to build wealth, there are countless avenues for investors to explore.  There is passive investing, active investing, crowdfunding, and countless other forms of ventures to invest in.  The purpose of this post is to cover some of the most common forms of investing where the transactions can occur with the click of a mouse.

Index Funds

Index funds are what their name implies.  An index fund is a mutual fund that is composed of stocks that track a specific index.  For example, if you buy a share of an S&P 500 index fund, you are buying an investment that is made up of the largest publicly traded U.S. corporations.

There is little actual management and turnover with index funds.  That is what makes them cheap and tax-efficient.  A management team is not required.  There is very little trading and turnover within most index funds.

There are index funds that track large-cap stocks, small-cap stocks, international stocks, and bonds.  There are index funds that hold every publicly traded stock in the world.  There are also index funds that track individual sectors or sub-asset classes such as consumer stables, natural resources, technology stocks, and other sectors.

An investor can keep it simple and buy three index funds like the total U.S. stock fund, total international stock fund, and total bond market fund that would allow them to own every publicly traded stock in the world.  An investor can slice and dice and break it down into many different funds and build a custom portfolio with different tilts.  There truly are limitless possibilities.

Managed Funds

Managed funds are like index funds.  They invest in a basket of different stocks or bonds.  The major difference is that they do not track an index.  They have a fund manager or team of managers who try to beat a benchmark.  For example, a managed large-cap growth stock fund would try to beat the S&P 500 index.

Compared to index funds, managed funds have higher fees.  The average expense ratio for a managed large-cap stock fund is 0.99%.  The expense ratio for the Vanguard S&P 500 is 0.04%.  That is almost one whole basis point.

The goal of the fund manager is to outperform its benchmark.  Based on the difference in fees, the fund manager must outperform the S&P 500 by almost 1% per year to just break even.  That is very difficult to do.  It is getting even harder as the result of the shrinking alpha.

For the fund manager to try to beat their respective benchmark, they need to make trades.  They are paid to buy stocks within the fund that they think will outperform.  They also must identify the stocks that they think will underperform and sell them.

All of that buying and selling is called turnover.  Some managed funds have a turnover ratio of 90% or more of their portfolio annually.  If a managed fund is held in a taxable account, all those trades trigger capital gains that are passed on to the investor.

Most managed funds do not beat their benchmark.  In 2016, only 34% of large-cap mutual funds beat the S&P 500.  It gets worse with time.  Only 10% of large-cap mutual funds beat the S&P 500 over the last 15 years.

What happens to the underperformers?  Usually, a new manager is brought in to right the ship.  If its performance does not improve, it normally merges with another fund.

Individual Stocks

Investing in individual stocks can be rewarding.  If you select the right stock, you will outperform the major indexes.  Just look at Google, Amazon, or even Apple.

The problem with investing in individual stocks is that it is hard.  Most active mutual fund managers who have unlimited resources cannot consistently do it.  It is not likely that an individual investor will outperform the S&P 500 for a decade or longer.

Can an investor get lucky when they buy a few stocks?  Sure, they can.  That, however, is speculation.  Investing is not gambling.

When an investor buys an individual stock, it is a vote of confidence in a company.  It is a vote that they know the stock is undervalued compared to its market price.  They are making a statement that says they know more about the fundamental business operations of the company and they are positive that it is sure to appreciate.

They do not know any of those details.  The individual investor receives their information from the financial media or a stock screener.  They are the last to know anything about the value of a stock.  The professionals, analysists, and insiders know before the media.  They provide the information to the media.  The media informs the individual investor.

Robo Advisors

Robo-Advisors are the new frontier for individual investors.  Robo-Advisors are financial management platforms that allow investors to manage their investments based on algorithm-based variables.  An investor plugs in their goals, risk profile, and other survey data and Robo-Adviser does the rest.

The technology used by Robo-Advisors is not new.  The investment industry has been using it to rebalance accounts since the early 2000’s.  It is new, however, for individual investors to have access to this type of asset management technology.

Even though it has been around for some time, it is fascinating technology.  Since it is automated and based off an algorithm, there is not much room for human error.  Not only can it be used for investment selection, but it can also be used for more sophisticated processes like tax-loss harvesting.

There are some nice benefits to using a Robo-Advisor.  They are a much more affordable option than having to hire a human Financial Advisor.  The annual fee to use a Robo-Advisor is between 0.2% to 0.5%.  That is much more affordable than must shell out up to 2% for a human financial advisor.  The minimum amount that is required to invest with a Robo-Advisor is much lower than the standard six-figure minimum that many traditional human financial advisors require.

Conclusion

The above investment styles are just a few of the more popular methods for individual investors.  Over the years, my portfolio has become primarily made up of a few index funds.  I have invested in a few managed funds but sold off all except one.  As far as individual stocks, I have only bought and sold five individual stocks since I started investing.  I have not owned any individual stocks since 2004.  Many investors in the financial independence community use individual stocks as part of their dividend strategy.  As for the Rob-Advisors, I have invested using that technology, but do see its value for tax-loss-harvesting in a retirement account.

What is your approach to investing?

Do you follow any of the methods that I covered or a blend of a few different approaches?

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Dumping Stocks at Retirement

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Have you ever considered selling all your stocks or stock mutual funds when you retire?  Who wants to have to deal with the ups and downs of the markets when you are no longer dollar-cost-averaging?  Are you afraid of a major market crash when you are drawing down your portfolio?

The market is near its all-time high.  With retirement right around the corner, are you tempted to sell all your stock holdings and call it a day?  It might sound tempting.  This market cannot keep going up, can it?

Every investor has the right to feel exactly how they feel about all of the scary things that are going on in the world.  Don’t lose your head.  The world has always been a volatile place and unfortunately, it always will be.  If it is not one thing, it is something else.

Yes, it might be tempting to pull the trigger and sell high.  You would walk away as a winner.  Before you do that.  Let’s look at how an all-bond portfolio might serve you in retirement.

For this exercise, let us assume that you are now sitting on $1,000,000 in your 401K.  At retirement, you want to draw down 4% per year.  How would an asset allocation of 100% in bonds hold up over the course of 30 years?  To find out, I am going to run this test based on the Monte Carlo method by using the Vanguard Retirement Nest Egg Calculator.

There is a 69% chance that your savings will last 30 years.  I do not like those odds.  I especially do not like them for a person who retires early.

What about if a person wants that $1,000,000 to last 40 years?  The percentages are getting much worse.  There is now only a 36% chance that money will last 40 years.

Could you imagine going broke after being retired for 40 years?  What would you do?  Would you go back to work?  Who would hire you at such an advanced age?  Sure, employers cannot discriminate, but let’s be honest about the opportunities for someone who has been unemployed for that long.

What could an investor do to improve the chances of their savings lasting 30 years or even 40 years for those who enter early retirement?  In Benjamin Graham’s book The Intelligent Investor, he gave a few suggestions for defensive investors.  He suggests that a balanced portfolio made up of 50 in equities and 50% in bonds is a good place to start.  He also suggested that an investor should never exceed an asset allocation of 75/25.  In other words, an investor should never have more than 75% or less than 25% in equities or bonds.

I know that you are seriously considering selling your equity holdings and exchanging them for bonds.  You have told yourself that you are finished with the market.  Volatility is no longer for you.  You want to enjoy your retirement without having to worry about how stocks are performing.  If you do that, the odds are still not in your favor of not running out of money.

How would your $1,000,000 fair if you followed what the late Benjamin Graham suggested in his classic investment book?  How would keeping only 25% in equities change the projected outcome?  Would adding a more volatile asset class help or hurt the likely hood of running out of money?

By keeping 25% in equities, the percentages have dramatically improved.  There is now a 78% chance that your money will not run out over the course of 30 years with a 4% drawdown rate.  Over the course of 40 years, there is 57% chance that your money will last.  By keeping 25% of the portfolio in stocks, there was an improvement of 9% over the course of 30 years and an improvement of 21% for 40 years.

Holding a small allocation of equities sure goes a long way.  What about if you took it a step further and went with a mix of 50% in stocks and 50% in bonds?  I know, I know. You are finished with stocks.  Keeping 25% of your money in stocks is one thing, but going to 50% is just too aggressive for your retirement account.

I understand how you feel.  You do not want to own stocks when the next recession occurs.  A long stock market correction can be scary.

During a drawdown period, how does having 100% in bonds compare to an asset allocation of 50% in stocks and 50% in bonds?  Over the course of 30 years, the 50/50 mix has an 85% chance of success.  Over the course of 40 years, the 50/50 mix has a projected success rate of 74%.  Compared to the portfolio made up of 100% in bonds, the 50/50 mix has a 16% better chance to not run out of money over the course of 30 years.  For the period of 40 years, the 50/50 mix has a 38% better chance of not running out of money.

There are many factors to consider when selecting the asset allocation that is right for your retirement.  How old will you be at the time of retirement?  How long does your money have to last?  How will RMDs impact your drawdown?  What type of lifestyle do you want to live during retirement?  Are you planning on leaving a legacy?

I am not trying to convince you on how you should allocate your portfolio during retirement.  That is ultimately your decision.  Everyone has a unique financial situation.  The purpose of this post was to examine how different conservative portfolios might perform during the drawdown period.  I am just trying to convince you to do your due diligence before you rush to any financial decisions that will impact your quality of life down the road.

After reviewing these results, it shows that diversification is still important during the drawdown period.  Just as holding 100% in stocks is too aggressive for most investors during their working years, holding 100% in bonds might be too conservative for investors during the drawdown period.  When an investor is working on building their wealth, holding a percentage of bonds helps to reduce the impact of how stock market volatility impacts a portfolio.  During the drawdown period, holding a small percentage of equities greatly improves the likelihood of not running out of money in retirement.

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Long-Term Care: An Overview

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As the saying goes, there are two guarantees in life.  The first promise is that you will die.  The second promise is that you will pay taxes.  There is also a third guarantee that should be mentioned.  If you are fortunate to live to old age, you are most likely going to need someone to care for you.

When people think of aging, they often fear the type of care that they are most likely going to need at some point.  While it is not as fun as planning for a trip around the world, long-term care should not be forgotten about.  It is much better to add long-term care in your financial plan than to hope you will never need it.  Long-term care is just another variable to be added and managed on the journey toward financial independence.

What is Long-Term Care

Long-term care is different from other types of healthcare and not covered by traditional health insurance.  The objective of long-term care is not to cure an illness or disease.  The main purpose of long-term care is to allow an individual to attain and maintain an optimal level of functioning as they age.

What do the average statistics look like for people who will need long-term care? Someone turning age 65 today has almost a 70% chance of needing some type of long-term service and support.  Women need care longer than men.  On average, women need 3.7 years of care and men need 2.2 years of care.  The difference in time is based on women living longer than men.  Based on today’s population of 65-year-olds, 20 percent will need it for longer than 5 years.

Where is Long-Term Care Provided

Most long-term care is provided at home.  Long-term care is changing.  As part of the Triple-Aim, along with being cost-effective, and high-quality, the focus needs to be community-based.

Of older people with disabilities who receive LTSS at home, 66% get all their care exclusively from their family caregiver.  This care is mostly given by wives and daughters.  Another 26% receive some combination of family care and paid help.  Only 9% of people who receive LTSS at home receive paid help.

Based on a 2013 report from the CDC, about 8 million people receive support from the 5 main paid regulated long-term care service providers:

  • 57% – Home Health Care Providers
  • 17% – Skilled Nursing Facilities
  • 15% – Hospice Care Units
  • 9% – Independent Care Communizes
  • 3% – Adult Day Services

What is the Cost of Long-Term Care

The cost of long-term care varies by region.  Long-term care is more expensive in the northeast than in the south.  Along with cost, quality standards also need to be considered.  Below are the median annual costs for my home state Pennsylvania:

  • Private room in a skilled nursing facility is $120,000
  • Private one bedroom in an assisted living facility is $41,000
  • Home Health Aide (44 hours of care) is $50,000

Who Pays for Long-Term Care

The total national LTSS spending in the U.S. is $310 billion.  On average, the retirement savings of families between the ages of 56 and 61 is $164,000.  The median for this population is only $17,000.  With the savings rates being so low and the costs so high, where does the funding come from?  Based on the CMS, the breakdown is as follows:

  • 8% – Private Insurance Providers
  • 19% – Private pay or out-of-pocket
  • 51% – Medicaid
  • 21% – Other Public sources

What is Long-Term Care Insurance

Long-term care insurance pays for care in your home, assisted living facility, community-based care center, and skilled nursing home.  The policies begin coverage wan an individual is unable to perform two of the six activities of daily living (ADLs) or are cognitively impaired (Dementia or Alzheimer’s).  The six basic ADSs are eating, bathing, dressing, toileting, transferring (walking), and continence.

Individual policies are commonly sold to individuals by insurance agents.  Employees policies are employer-sponsored benefits that might be offered as a group long-term care insurance plan.  Association policies are group insurance policies that are offered by associations such as AAA or AARP.

Some states have long-term care insurance partnership programs.  When you buy a federally qualified partnership policy, you will receive partial protection against the normal Medicaid requirements to spend down your assets to become eligible.

Some federal income tax advantages are available to people who buy certain long-term care insurance policies.

Sales of traditional long-term care policies have fallen sharply, but life insurance policies and annuities that carry long-term care benefits are growing in popularity.

Most people who buy long-term care insurance do so between the ages of 55 – 65.

Who sells Long-Term Care Insurance

According to Consumersadvocate.org, the top 5 providers of long-term care for 2018 are:

  • Golden Care
  • LTC
  • CLTC Insurance Services
  • Mutual of Omaha
  • Mass Mutual

Conclusion

Most people would like to pretend that long-term care is not a fact of life.  Unfortunately, it is something that most people will have to deal with.  While it is not a light-hearted topic, it is a good idea to discuss it with those who you might have to care for as well as with those who might have to care for you.   As with every other aspect of personal finance, long-term care is another issue that needs to be part of a financial plan.  It is always better to have a plan and not need it than to be faced with a life-altering situation and not have a plan.

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Should Millennials Contribute to a 401K?

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No, that is not a rhetorical question.  I was having lunch the other day with my co-worker Jill.  Jill is an exceptional young woman.  Jill’s parents divorced when she was young, so she grew up in a broken home.  That did not stand in the way of her excelling in school.  She went on to earn a BA in Psychology from one of the best state universities in the country.  She is also considering going back to graduate school for a Master’s Degree in Public Administration.

Jill and I have worked together for almost one year.  Jill was lucky because she was hired just a few months after she graduated from college.  She is a great employee, person, and is highly ambitious.

She told me that she developed her work ethic as a young teenager.  She said that growing up without a dad around, she had to work to help her mom pay the bills.  Jill started working at age 14 and has always had a job during high school and while in college.

When we were talking, she told me that when her parents divorced they had an agreement to give each child $40,000 towards their college education.  Her brother went to Notre Dame and the money he received from his parents covered about one year of his education.  Jill opted for a state university that was only a 2-hour drive away from her Mother.

Jill’s education cost her parents $30,000.  Her parents tried to be fair about the dollar amount.  After graduating college, her parents also bought her a used car for $10,000.  Even though she did not get to watch the Fighting Irish play football in South Bend, she still made out well.

During our lunch, she told me that she feels bad for her current roommates.  Most come from families that are more affluent than her family. However, they all have student loan payments that cost $700 or more every month.

She asked me my opinion about her situation.  Should she feel bad?  What should she do with the extra money she has compared to what her roommates have?  She said that she did not grow up with much and does not want to waste it.

I told her that she is in a fortunate situation.  She has a unique opportunity to save a great amount of money since she does not have any debt and her only large bill is her monthly rent.  I suggested that she pretends that she has as much student loan debt as her roommates and to contribute $700 per month to our employer’s retirement plan.

She asked me “Should Millennials contribute to a 401K”?

I told her that millennials should absolutely contribute to a 401K.  I said that she especially should because she does not have any debt to pay back or major bills.  These are the reasons why she should start contributing:

  • She is 22 years old and by starting at that age, she can be well on her way toward financial independence (FI) in 15 years or less
  • Our plan offers low-cost index funds
  • Our employer matches 100% up to the first 5% an employee contributes
  • The contributions lower her taxable income
  • The money grows tax-free and is not taxed until she withdraws it at retirement
  • She can take advantage of dollar-cost-averaging
  • She can enjoy the benefit of compound interest
  • If she gets a different job, she can take the money with her and roll it over into an IRA
  • Even though I would advise against it, she can borrow against her account if need be

I explained to her that time goes by very quickly and she has a golden opportunity to build some serious wealth for herself.  Unless she lands a government job, she will not have a pension.  She will need this money to support herself in the future.

Jill has a unique situation.  She is a young millennial without any debt.  What makes her even more unique is that she is a new college graduate without any student loan debt.

If you have student loans, you should still contribute to your employers 401K account.  Even if it is just enough to get the match.  After you pay down your debt, take the dollar amount that you were paying towards your loans and direct it to your 401K.

You might not get to Financial Independence as quickly as Jill does.  You will, however, get there if you take a few steps.  If you have debt, pay off your debt and don’t create new debt.  Save as much as possible.  Sign up for your employers 401K plan as soon as you are eligible.

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Note: This post was originally published as a guest post.  The post was moved here because it was not available to be read on dollardiligence.com. That site is no longer active.

Early Retirement: Removing Barriers

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Many people dream of reaching early retirement.  Few people, however, are willing to do what it takes to make it a reality.  In most cases, to reach early retirement, a person must live differently from how the masses live.  People generally don’t want to be viewed as being different from their fellows.

The masses are living for the day, spending most of what they earn, landing in debt, and are in denial about their personal finances.  They have high hopes that their financial future will be secure.  Hope, however, is not a strategy.

To reach early retirement, a strategy is needed.  That strategy will require action and more action.  The primary objective of that strategy will be to first reach financial independence.  Financial independence is what enables people to retire early.  If a person is no longer working, the money to sustain their lifestyle needs to come from somewhere.  For most early retirees, that somewhere is their passive investments.

The path to being able to retire early is full of barriers.  Many are external like being able to maintain a budget while marketers are doing everything they can to get you to break your budget and buy whatever it is they are selling.  Some barriers are mental.  The purpose of this post is to identify a few of these barriers and to establish a plan of action to avoid them.

Ignorance

Most people are unaware of what is required when it comes to planning for an early retirement.  That is even true for those who have attended college.  People who hold a 4-year degree or beyond still struggle with doing what is required to escape having to work for a living.

When it comes to establishing a financial plan, many people truly do not understand what is required.  They feel that things will just work out like they have in other areas of their life like landing a good job or getting a mortgage to buy a house.  They are generally in denial about what is required to build a large enough net worth to sustain their desired lifestyle once they are no longer working.

The good news is that once a person decides to learn more about personal finance, there is an abundance of great information.  Once a person takes that first step towards learning about budgeting, saving, and investing, they have removed one barrier.  Once that barrier has been removed, they will discover that the basics can carry a person a long way.  The basics alone might be enough to carry some people to financial independence.

Procrastinating

Procrastinating is another barrier that stands in the way of reaching early retirement.  Not knowing about a topic is one thing.  Knowing and not doing anything is another.  To reach early retirement, it takes many years of earning a salary, saving a large percentage of that income, and investing it wisely.

The longer a person waits to start this process, the harder it becomes.  That is based on compound interest.  Let’s assume that an investor needs to have $1,000,000 saved to declare financial independence.  They also want to reach this milestone by age 50.

Based on an 8% percent return, if an investor starts to save $1,800 per month at age 30, it will take 20 years to reach their goal.   If they wait until age 40 to start saving, they will have to save almost $6,000 per month.  If they started at age 22, however, they would only have to save $900 per month.

When you are young, time is on your side.  The older you get, the harder it becomes.  Don’t procrastinate if your goal is to reach early retirement.

Not investing in stocks

To receive a return close to 8%, an investor will need to have a large percentage of stocks in their asset allocation.  Based on how investments are projected to perform for the next 10 years, an 8% return might not be reasonable.  Large-cap stocks are projected to earn 6.7% threw 2026.  For that same period, investment grade bonds are projected to earn 3.1%.

The average person has the tendency to shy away from stocks.  In the short-term, they are volatile.  Over long periods of time, they are one of the best wealth building investments for individual investors.

Instead of parking your money in a money market that returns 1%, consider adding stocks to your asset allocation.  A good place to start is to look at a balanced portfolio of 60% stocks and 40% in bonds.  This allocation is popular because it provides growth from the stock allocation and the bond allocation reduces volatility when the stock market has a correction.  Another general rule of thumb is to invest (110 minus your age in stocks).  If you are age 25, you might want to consider having around 85% of your asset allocation in stocks.

Lifestyle Creep

Lifestyle creep is a form of inflation.   As a person advances in their career and their earnings increase, it is natural for their spending to increase.  As raises and promotions pile up, people have the tendency to upgrade their lifestyle.  Instead of saving more of their earnings, people buy bigger houses, fancier cars, and go on expensive vacations.

If there is lifestyle creep in your life, it is a major barrier between reaching early retirement and being stuck as a wage earner.  Lifestyle creep inflates how much money you need in your retirement account before you can retire.  In contrast, if you keep your monthly expenses low, the less you will need to be able to retire.

If you plan on withdrawing 4% from your retirement account, have $100,000 in annual expenses, you will need $2,500,000 in retirement savings.  For those who only have $40,000 in annual expenses, they just need to save $1,000,000.  The higher your annual expenses are, the more you need to have in retirement savings.

To avoid lifestyle creep, some management is required.  A solid budget is needed.  A financial plan is also a vital tool.  First, focus on the big expenses.  Keep your housing, transportation, taxes, and education costs low.  For example, live in your starter house forever, buy an economical car, live in an area that does not have high taxes, and take advantage of public schools and state universities.

If you can avoid lifestyle creep on the major expenses, you will have more money for savings.  This will also lead to less financial stress.  Instead of stressing to cover your bills that are always increasing, you will be able to better enjoy your life because there will be less demand for having to earn more and more.

Conclusion

For most people, the road to early retirement takes a long time.  It generally takes a couple decades of solid earnings, a high savings rate, and compound interest.  To achieve this ambitus goal, there are barriers that need to be identified and managed.

To be successful with personal finance, education is required.  The great news is that there is an abundance of good books, blogs, and forums that provide unlimited information.  A good place to start is the Resources page on this blog.

There is no such thing as an overnight success.  Most overnight success stories have been a fifteen-year work in progress.  If you want to be financially successful and retire early, start today.  It is not an overnight endeavor.

Without some risk, there will only be a little return.  Identify the correct mix of stocks and bonds for your situation.  Be sure to take your age and risk tolerance into consideration.

Manage your expenses.  The greater your expenses, the more money you must save and grow.  By keeping your expenses low, the less money you will need in retirement.

There will always be barriers that stand in the way of reaching early retirement.  Once they are identified, they can be managed and overcome.  Keep your eyes open for other barriers that might pop-up.  Be vigilant and stay focused and you will be sure to reach financial independence and retire early.

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