Retirement Planning – The Easy Way

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Here is the latest of my financial planning articles from one of our specialty society newsletters:

Retirement Planning – The Easy Way

Here is the text as well:

The previous installment of “Dollars & Sense” reviewed the principles of investing for retirement, and this article discusses an easy way for physicians to plan for retirement. It isn’t necessarily the best way and certainly isn’t the only way, but it is a plan that will likely lead to a very successful and potentially even early retirement.

Step 1 – Calculate How Much You Need to Save for Retirement

Total up your household’s gross (pre-tax) income for the year. Include all sources of income, literally all the money you make from anywhere. Multiply that number by 20%. That is how much you need to save annually for retirement. While the traditional recommendation is that you save 10-15% of your income for retirement, saving 20% (or more if you can) will ensure you save enough and have the option of an earlier retirement or the freedom to cut back on your workload at some point.

As an example, let’s pretend your household makes $300,000 annually before taxes. Multiple that by 20% and you’ll see that you need to save $60,000/year for retirement.

Step 2 – First Fill All Your Tax-Advantaged Retirement Accounts

You likely have many different retirement accounts available, so here is the order in which you should invest. Start with the first action and move down the list.

1. Contribute to any employer-provided retirement account up to the maximum that your employer will match. This is free money you can’t afford to leave on the table.

2. Maximally fund any tax-deferred retirement accounts you have, like your 401k or 403b. If you are self-employed you may have other options like a SEP-IRA or individual 401k.

3. Fund an IRA for both you and your spouse/partner, if applicable. If your income renders you ineligible to contribute to a Roth IRA but you still wish to do so, use the “backdoor” Roth IRA approach.(https://personal.vanguard.com/us/insights/video/2505-Exc2)

4. Put any remaining retirement funds into a taxable mutual fund.

You may have other options, such as funding a Health Savings Account as a “stealth IRA.” Some believe in using life insurance as an investment, but I don’t recommend that. In general, after you’ve maxed out the contributions to all of your tax-advantaged accounts, you’ll have to put the rest in a regular, taxable investment account.

For some of the options above you’ll have to decide whether to pursue a Roth option (pay taxes now) or use the traditional tax-deferred approach (pay taxes when you withdraw the money in retirement). That decision will depend on your individual financial situation, current and anticipated future tax brackets, and what options your employer offers. There are many on-line calculators to help you decide this.

Using our $60,000 example from above, you would contribute $18,000 to your 403b, and then fund $5500 toward an IRA for both you and your spouse, leaving $31,000 to put into a taxable investment account. If your employer contributes to your retirement, you could also count that amount toward your $60,000 total contribution.

Step 3 – Invest Your Retirement Savings in Low Cost, No Load, Index Mutual Funds

You will have to take a look at the investments offered by your various plans and select from that menu. The principles that should guide you:

1. Favor index funds over actively managed funds. You’re investing for the long term, and over that time frame almost no actively managed funds will beat index funds. In addition, because past performance does not predict future performance, there is no way to predict which funds will beat their indexes.

2. Favor mutual funds with low expense ratios that do not charge a load. The expense ratio should be less than 1.0, preferably less than 0.5, and optimally less than 0.25. If you want to keep this really easy, just invest in Vanguard index funds as all of them meet these criteria.

3. Realize that in order to beat inflation over the long haul, you’ll likely need to invest some of your portfolio in stock index funds. What percentage you invest in stocks will depend on your time horizon, risk tolerance, and individual situation. A number of guidelines from trusted references are below:

  • Malkiel & Ellis suggest this as a conservative asset allocation:
AGE GROUP PERCENT IN STOCKS PERCENT IN BONDS
20-30s 75-90 25-10
40-50s 65-75 35-25
60s 45-65 55-35
70s 35-50 65-50
80s+ 20-40 80-60
  • They suggest this as a more aggressive asset allocation, which is my personal favorite due to the security offered by my inflation-adjusted military pension:
AGE GROUP PERCENT IN STOCKS PERCENT IN BONDS
20-30s 100 0
40s 90-100 10-0
50s 75-85 25-15
60s 70-80 30-20
70s 40-60 60-40
80s+ 30-50 70-50
  • John Bogle suggests, as a conservative asset allocation rule, that your percentage of assets in bonds should equal your age. In other words, at age 30 you should have 70% in stocks and 30% in bonds. A more aggressive version is to subtract 10 from your age, so at age 30 you’d have 80% in stocks and 20% in bonds.

One very easy way to let someone else make this decision for you is to pick a target date retirement fund as your investment vehicle. Many investment companies offer these. You just pick the approximate year you plan to retire – that year will likely be in the name of the fund (Target Retirement 2035, for example) – and invest in that fund. Your investments will gradually get more conservative as you age without any action on your part. Just make sure that the target date funds you have access to are composed of index funds with low expense ratios. Again, using Vanguard funds makes this a no-brainer. A target date retirement fund composed of actively managed funds with expense ratios greater than 1.0 is a target retirement fund to avoid.

To close out our running example, for your 403b you invest in the target retirement 2040 fund offered by your employer’s investment firm. For both of your IRAs and your taxable account you apply the KISS (keep it simple stupid) principle, open all of them with Vanguard, and select their Target Retirement 2040 funds for all three accounts.

A simple approach like this should set you up well for retirement, and is easy enough that you can use the time you would have spent trying to manage your finances to play a little golf every now and then.

  • References

Bogle, John C. The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. Hoboken: John Wiley & Sons, Inc., 2007.

Malkiel, Burton and Charles Ellis. The Elements of Investing: Easy Lessons for Every Investor. Hoboken: John Wiley & Sons, Inc., 2013.

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