Get Financially Fit!

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How do you feel overall about your personal finances?  Are you in shape to hike up Mt Retirement? Could you survive in the financial wilderness if you had a setback such as a job loss?  I have created a financial fitness survey to help you assess different areas of your personal finance.  Please take a minute and complete the financial fitness survey on the next page.  The purpose of this survey helps you identify areas both where you are doing well and areas of improvement for your personal finance life. This survey should take less than 5 minutes to complete.

A complimentary PDF version of this test post at book resources 

How did you do on the survey? The purpose of the survey is to show you areas where you’re doing well and areas where you can improve. If you got good scores (4 or 5) on most of the questions then you are in good shape - congratulations!  If you got low scores (1, 2 or 3) on the majority of the questions, don’t feel despair. Through focus and continuous improvement you will become financially fit. As you become more financially fit, you will experience less stress and be able to pursue your passions and live your purpose.

Follow your dreams, Achieve your goals!

Photo Credit:US National Oceanic and Atmospheric Administration 

I’m sure that you have heard the airline pilot say many times to buckle your seatbelt since there is the chance of turbulence ahead. On a flight to Texas the pilot gave this standard advice.  The overhead seatbelt light came on and I heard a couple of clicks nearby.  I have always been an obedient passenger so I didn’t need to buckle my seatbelt.  We entered some mild turbulence within several minutes and then all of a sudden (gasp) the entire plane fell faster than any roller coaster ride that I have ever been on. I observed the beverage cart jump 6 inches off the ground, the flight attendant hit the ceiling, and about one out of four passengers rose a foot out of their seats.  The intensity was so significant in the the plane that you could hear people taking breaths over the roaring of the engines.  After the 3 second free fall the plane quickly leveled. Within seconds of stability all you heard was .. CLICK CLICK CLICK CLICK CLICK CLICK … The pilot came on the overhead speaker and indicated that we had hit an air pocket that caused the plane to drop.  He indicated that we were fortunate in that we only hit a moderate pressure drop.

What impressed me most about the remainder of the flight was that the flight attendant locked herself in her seat and refused to get out. She was so shaken up that I wouldn’t have been surprised if she quit her job after that flight.

Why am I taking the time to tell you my air travel woes? Right now the market is quite turbulent.  Many people are not very comfortable and they want off the plane.  When I fly today I know there are risks of turbulence, but I believe overall that the time benefits and safety of air travel outway the cost of driving across the country.

I believe investors need to take at least a 5 year time horizon.  We are invested in the market for long term results, short term turbulence is a natural part of investing.  Given the reasonable PE ratios of the market I’m going to keep my seatbelt fastened and continue dollar cost averaging in new money.

What are your thoughts about the turbulent market?

There are two types or IRAs, Roth and traditional.  Roth IRAs are great for new investments since the money grows tax free.   Of course if you exceed the income limitations then a traditional IRA is the next best option. The traditional IRA is used when rolling a 401K or 403b plan from your employer. I recommend setting up automatic monthly withdrawals from your checking account for discipline. The table below details the difference between the Roth and traditional IRA and the contribution limits.

 The contribution limit for IRAs increased to $5000 in 2008 ($6000 if you are 50 years old).  In future years the contribution limit will be indexed to inflation.

Follow your dreams, Achieve your goals!

If you don’t know where you are going, you’ll end up somewhere else.
-Yogi Berra

Once when hiking in a wilderness area, a tired and weary hiker approached me and asked directions to the trailhead. I pulled out my hike book and showed him the trail map. Quickly he identified the route back to his car. He thanked me, and with new energy he hiked off. I felt a great sense of satisfaction helping the hiker get back on course. I then thought, “How could he have gotten lost, there are only two turns that he had to make?” Later that day as I headed back toward the trailhead it became evident how the hiker missed a key turn. The path to the trailhead was so faint and the main trail was so dominant, you would have guessed it was a game trail. My thought at that point was, “Who would walk in the wilderness without a map?”

Do you have a financial plan? A clear map to help navigate you to retirement security and financial independance? I have created the following financial steps to to guide you through the finanical wilderness.

A complimentary PDF version of this test is posted at book resources 

1. Define your goals
Write down your dreams. Identify, clarify, and prioritize your goals. For each goal track the next actoin step that you can complete. Keep your goals visible and review your goals weekly.

2. Live within your means
Pay as you go! Spend less than you make every month. Maintain a balanced checkbook, put your credit cards on sabbatical, eliminate impulse purchases, save up for large purchases, detail your monthly cash flow, and reduce fixed and variable expenses. Achieving your goals is the motivation to reduce your spending.

3. Create and emergency fund
Create an emergency fund that is one-quarter of your montly living expenses, then gradually increase to a full month of living expenses. Only use the money for true emergencies such as medical expenses and car repairs.

4. Eliminate high interest debt
Eliminate all credit card and consumer (i.e. auto loans, student loans, etc) with greater than or equal to 6% interest. Attack outstanding loans with the highest interest rates and lowest remaining balances first.

5. Contribute 10% to retirement savings
Save 10% of your salary for retirement. Use automatic deductions and payments to contribute to your 401k/403b or a Roth IRA. If you can’t immediately save 10% of your income then take advantage of any matching available from your employer in your retirement plan. Increase your contributions both when you achieve pay increases and when you eliminate debt. Commit to save for the long haul. When changing jobs, roll your retirement plan to an IRA - avoid the temptation to cash out the money.

6. Pay off credit card and consumer debt
Attack and prepay all debt greater than 4% interest. Debts lower than 4% interest rates can be paid on the regular schedule. Do not incur any new consumber debt (i.e. auto loans, home equity lines of credit, etc). If you use credit cards then pay off the balance every month.

7. Fully fund your rainy day fund
Be prepared for the loss of a job or a serious medical event. Rainy day reserves help make lifes difficult transitions manageable. If you’re under 30 years old, save 3 months worth of living expenses. If you are between 30 to 40 then save 6 months of living expense. Above 40, accumulate 12 months of living expense.

8. Maximize retirement savings contributions
Fully contribute to your 401k/403B plans and Roth/traditional IRAs. Continue increasing your contributions until you reach 15% of your income. Either invest in index funds to keep expenses low and achieve market performance or invest in no-load mutual funds that outperform index funds.

9. Continuously build equity and then pay off your mortgage
Purchase a home with 30% down and fixed 15 or 30 year morgage. Do not take out home equity line loans. Pay off your mortgage to reduce your living expenses and achieve peace of mind.

10. Achieve retirement security / financial independence
Financial independence is the point at which your assets provide the necessary income to cover your expenses. You are now in the position to pursue your passions full time. You also can increase your giving.

Follow your dreams, Achieve your goals

How is your journey going?  What step number are you on?

How much can you withdraw from your nest egg when you are in retirement?  In the field of mathematics is a statistical method called Monte Carlo Simulation (named after the gambling city in Europe).  Monte Carlo simulation involves completing calculations for many probable scenarios to help in decision-making.  In the example of withdrawing money out of a retirement account the key parameters are the percent of the portfolio withdrawn each year and mix of stocks and bonds in the portfolio.  Through calculation of over a hundred of scenarios using historical stock and bond returns, the success rate of your retirement scenario can be evaluated.

A web site that explains this concept in more detail and provides a calculator (Called FIRECalc) to predict how long you can survive off of your nest egg is: http://www.fireseeker.com/   I recommend that you run the calculator multiple times to see how your annual spending, nest egg size, percentage of portfolio in stock, and expense ratios impact how long your money will last.

Using the FIREcalc calculator and these assumptions:
1) Portfolio of 50% stocks and bonds
2) 30 years in retirement

I found the following results:

The table above reveals that the life of the portfolio increases as the withdrawal rate decreases. Of course this in not surprising, but it helps to see that a 10% withdrawal rate will last about 12 years, a 7% withdrawal rate will last 20 years, and a 4% to 5% withdrawal rate will last 30 years or longer.These calculations are assumed a historical rate of inflation and a balanced portfolio of 50% stocks and 50% bonds.  In practical terms this means that every $100,000 in retirement savings, provides an annual income of $4,000.  Conversely if you desire an annual income of $80,000 then a $2,000,000 portfolio is required.  The following table shows the relationship between nest egg size and withdrawal annual income. 

Follow your dreams, Achieve your goals!