Listen to the early-retirement trailblazers: by far the most common comment of the new posters on Early-Retirement.org and other Internet retirement discussion boards is “I wish I’d started saving and planning sooner!” That’s not much consolation if you’re reading this during your 19th year of military service, but the good news is that you still have time to let the magic of compound interest work in your favor. You can also make other lifestyle decisions that will accelerate your retirement date.
The next few sections will talk about financial-planning issues that are specific to the military and to early retirees. The discussion will assume that you have some experience with the basics of saving, investing, asset allocation, and budgeting. If this is your first hard look at these concepts then you have some “Recommended reading” to do from the back of the book. If you’re familiar with the basics then you’re going to learn about ways to optimize your investing and spending to take advantage of your new military and retirement assets.
“You’ll need xx% of your pre-retirement income for retirement spending.”
This canard comes from 1980s research that found the cost of commuting, childcare, and office attire was about 20% of employment-related expenses. The financial press picked it up and turned it into a thumbrule. I’ve spent years looking for the original study that led to this sound-bite summary, and I’d appreciate hearing from you if you come across it.
The reality is that once again: “It depends”. You may need as little as 25% or as much as 150% of your pre-retirement income, and you can control a great deal of that variance. This is especially complicated if you’re earning special pays, bonuses, or other allowances. Your retirement expenses will depend on the size of your family, your housing costs, your entertainment & travel spending, and your retirement area’s cost of living. Don’t even waste your time looking at the percentages. Your time will be much better spent figuring out where you’re going to retire, what activities you want to spend money on, and what your budget might look like. Then you can figure out how much you’ll have to save!
“Avoid risk by diversifying. You have to invest xx% of your retirement portfolio in stocks, another xx% in bonds, another xx% in commodities, and…”
“Risk tolerance drops with age. Your stock asset allocation should be ‘120 minus your age’ and should be adjusted every year.”
“Individual stocks are for losers. They’re too risky.”
“You can handle the risk of individual stocks and bonds. You have to steer your asset allocation around the yield curve, unless interest rates go down, but then…”
Whether or not you understand this vocabulary, once again: “It depends”. Asset allocation is one of the most important factors in the return of an investment portfolio, but that allocation depends on how hard you want to work at it and your tolerance for various types of risks.
Some investors are absolutely fascinated by the financial world and prefer to spend hours a day learning about asset classes, analyzing individual stocks, researching commodities futures, and even buying special data feeds for day-trading. Others would prefer to “set and forget” so that they can live their lives without having to keep an eye on the markets. You have to decide what level of effort you’re willing to exert and whether or not you want to keep it up for the rest of your retirement. You may not want to work so hard when you’re in your 80s, and your spouse may not want to take over a tricky stock portfolio if you’re no longer able to make the decisions.
One aspect of “risk” is volatility, which greatly affects your investor psychology. Some abnormally calm retirees may be able to watch their portfolio drop 25% in a month while others can’t sleep at night after a 2% drop. (No investor has ever complained about “upward volatility”.) Logical financial analysis is worthless if your portfolio scares you or if your spouse is uncomfortable with the type of assets you’re holding. See Appendix F for more discussion about asset allocation.
If you’re planning to work for a paycheck after you leave the military, then your asset allocation should reflect the “human capital” that you’re depositing on every payday. You can be much more aggressive with your investments when your spending money comes from paid employment. Pensions are the equivalent of another type of asset– the highest-quality Treasury bills or I bonds. If you’re receiving a pension (or if you’re going to receive one later as Reservists/National Guard do at age 60) then your other savings need to reflect that pension as a portion of the total assets. With a substantial portion of your assets in one of the world’s best inflation-protected annuities, especially if it pays your expenses, then you can afford to put more of the rest of your assets into more aggressive equities. If you’re ready to do this then be sure that you’re also able to sleep at night.
“You can’t retire, inflation is too high!”
This is why you should consider maintaining a high percentage of your savings in equities. In over a century of data, they’re the only asset class to beat inflation. Your pension has a COLA (and so does Social Security) but your personal rate of inflation may not match the official government CPI that determines the pension COLA. Keeping a significant portion of your assets in equities will give you both a hedge against inflation (your pension) and a weapon to beat it (your equities).
Here’s the conclusion:
“Your savings need to be absolutely safe.”
A huge investing epiphany for most military early retirees is realizing that their personal savings might not have to last forever. They may only need to cover the time they retire from the military until their additional pensions kick in from bridge careers, civil-service employment, or Social Security. Instead of choosing assets that may be eroded by inflation (like most bonds or certificates of deposit), ERs may decide on a budget that includes consuming a portion of the portfolio before additional pensions (or Social Security) kick in. It may be worth the volatility risk to invest in higher-return assets (like small-cap value stocks, real estate trusts, or commodities) and liquidate a portion of the portfolio every year.
“Low-cost index funds are the way to go. Active investors can’t beat the market.”
“Warren Buffett beats the market every decade and we can too!”
“Why settle for average when you can pick a great active money manager?”
Few debates generate as much controversy as these statements. The vast majority of investment managers never beat their fund’s benchmark, but one or two of them have beaten it for at least 15 years. The vast majority of investors are also unable to beat the market, but investors like Warren Buffett continue to sublimely soar above the averages for decades. So who’s right?
They’re both right, and you have to decide which path you’re going to pursue. You may have the innate skills of a Buffett, but like him you also have to be willing to make it your life. You may need to read a half-dozen newspapers a day and devour hundreds of financial reports a year while keeping in touch with dozens of business executives and investment managers. Do you find it absolutely fascinating, even compelling? Are you willing to put in at least 40 hours a week or longer in the pursuit of one needle among those haystacks of reports? Do you have Buffett’s guts to “Be fearful when others are greedy and greedy when others are fearful?”
Maybe you’re not Buffett (very few are) but you’re confident that you can find the next Buffett. Or can you? Can you find the next hot fund manager for the next four or five decades? Can you sift through thousands of funds and make sure that they won’t change their management or objectives after you invest with them? Are you willing to keep up with the research, the monitoring, and the workload for the rest of your life– or would you rather have a life?
You can beat the market if you’re willing to work at it and if you can recover from your mistakes. For everyone else, there are low-cost passive index funds.
“I’m not touching the market right now. It’s too expensive.”
“I’m not touching the market right now. It’s going down again and it won’t recover for years.”
“You have to invest with every paycheck, no matter how the market is doing, or your savings won’t grow fast enough.”
“I’m waiting until the Federal Reserve lowers the discount rate, the commodities futures index has stabilized, and the dollar strengthens against the yen.”
Every one of these excuses may be a great reason not to invest for a retirement goal, but they’re all excuses.
Research has found that the stock market rises approximately two-thirds of the time, largely in a random and unpredictable fashion. The stock market is not always driven by fundamental financial values, either– greed and hysteria are the common emotions, amplified by the media and investor psychology. Sitting on the sidelines waiting for the “perfect” moment is one of the biggest risks of all: the risk that inflation will erode the waiting cash and miss months or even years of compounding. While it is possible to time the market, it’s nearly impossible to continue to time the market correctly through decades of retirement investing.
The vast majority of investors choose to add money to their retirement portfolio whenever they get it, which is usually with each paycheck. Some investors add the same amount every time (dollar-cost averaging or DCA) while others add more to their lagging investments and less to their strong performers (value-cost averaging). Every method has its advantages and drawbacks but they all instill a discipline of routine investing that can be put largely on autopilot.
Ironically, DCA does not perform as well as “lump-sum” investing. For the best historical returns, all money should be invested as a lump sum on the first day it’s available. The reality is that this approach takes a cast-iron constitution approaching blind faith, and very few have the courage (or the blissful ignorance) to even consider attempting it. The real value of DCA is that it’s a decision to make once and then automate with a checking-account deduction.
There are thousands of other investing myths, but by now the point has been made that there is no single best way to save for retirement. Each decision has both a financial and an emotional side, and each side has to agree before the decision will stand. Your supremely logical reasoning is also wasted if your partner can’t tolerate the volatility or the other risks.
The best way to build the confidence to continue to save and invest under all circumstances is to educate yourself. As you become more educated and experienced, your temperament will evolve to handle other types of investment strategies. You’ll face the uncertainty with greater confidence and you’ll be able to ignore the market’s short-term volatility to stay focused on your long-term goals.