Today’s post is from an officer who wants to remain anonymous while sharing his pay & investment data. Two of the links include Excel spreadsheets that you can download and review, and when you click on them your computer may attempt to launch your spreadsheet program. If you decide to use them for your own retirement planning, please contact me to discuss their assumptions. And if you find an error, please let me know!
Most bloggers are reluctant to offer blunt advice. They are always hedging their bets with things that you should take into consideration: risk tolerance, expected withdrawal rates, life expectancy, etc. Rarely will they spell out exactly what you should do, or give their opinion of the best product or company. Why is that? Have they given advice that backfired? Do they rightly recognize that everyone’s circumstances are different, and therefore one size fits all advice is potentially dangerous? Probably so, however, where does that leave us? Where can we turn for real honesty that allows us to see where we stand in relation to others and possibly learn from their mistakes and successes? The way around that is to compare yourself with someone in a similar situation. The problem is that very few people are willing to share that level of detail for the world to see, and revealing something as private as your financial net worth feels a lot like standing around in your underwear.
So, I won’t give advice, I’ll simply hide behind the anonymity of the Internet and engage in a bit of financial exhibitionism / voyeurism. The relevant facts: I am a US military O-5 (lieutenant colonel or commander) with 19 years of active duty service. Married (since 1999) with 3 kids. Should I have saved more?…absolutely. The forcing function of gathering my own financial details while writing this article showed me just how much of an opportunity I have squandered. I’ve received $1.27 million in base pay, BAH, and BAS since 1994. (See the attached Excel chart.) What do I have to show for that? Not much…some great memories and a houseful of furniture, but only a tiny % of that can be found in my investment accounts. The rest…over a million dollars, slipped through my fingers…and here I thought I was doing a pretty good job. So, how did it happen? Read on my friend.
Part I: The Background
My own investing journey started in 1983 at age twelve with a gift of 13 shares of Johnson & Johnson stock and an associated Dividend Re-Investment Plan (DRIP). I thought it was the greatest thing ever, and would pester my family to buy Johnson & Johnson products whenever we went to the store. I would diligently save up my lawn mowing and leaf raking earnings to send in and purchase additional shares. Looking back, I have mixed feelings about giving a child the gift of shares in a single stock. While it doesn’t represent a very diversified portfolio, it certainly hooked me. I would check the daily stock price in the newspaper and celebrate each and every 2 for 1 stock split. However, I believe a better option would have been to introduce a child to the concept of passive investing through low cost index funds (more on that later). I understood early on that costs mattered, and buying shares direct from the company was the cheapest method I could find (after the initial brokerage fees are paid during the purchase of the first share(s)…paid by someone else in this case).
I entered college in 1989 with about $12K and promptly began a spending spree on beer. It became apparent that my spending was out of control and I wasn’t going to be able to pay for 4 years of college at the rate I was going, so I succeeded in getting an ROTC scholarship that helped to stanch the outflow of funds. I held down a number of jobs throughout my final years in college, but didn’t really add much to my net worth. However, I also avoided any student loan debt.
In college, I had an ROTC instructor that taught an elective course on money management. He introduced the cadets to the concept of mutual funds and dollar cost averaging. However, he didn’t stress the importance of low costs and he believed in actively managed mutual funds. I passed on the Fidelity Destiny funds that he recommended due to the high up front fees. However, I was intrigued with the idea of the diversification that mutual funds offered.
Upon graduation in Dec 1993 (yeah, I was a slow learner…it took me 4.5 years to graduate), and reporting to active duty in Jan 1994, I immediately began funding a traditional IRA with Twentieth Century Funds (back dated to max out my 1993 yearly limit of $2000 at the time). I also began researching other “Blue-chip” stocks with DRIPs and set about trying to build my own diversified portfolio. In addition to the aforementioned Johnson & Johnson stock, a look at some of my old tax returns indicate dividends received from: McDonalds, AT&T, Coca Cola, and Nike. I fancied myself to be quite a sophisticated investor. Yes, I thought I was pretty smart. However, I embarked on a series of training schools, then reported to Korea for my first duty station and promptly forgot about following my investments. I continued to send in my monthly IRA contribution of $166.66…and somewhere along the way I started contributing via dollar cost averaging to Janus Mercury and Janus Worldwide in taxable accounts, but that was the extent of my involvement in my investments. I would generally only look at the statements at tax time. So, it came as a bit of a shock to me several years later when I opened my statements and saw that I now owned shares of AT&T Wireless, Avaya, NCR, and Lucent Technologies as a result of a stock spin-off from my AT&T shares. I sold my shares in the newly acquired companies, except for Lucent, which according to my readings at the time was destined to make me a small fortune. I once again began to ignore my investments and missed the spectacular rise of Lucent Technologies and only caught it on the way back down after it had already lost more than 50% of its value from the peak. Oh well, by this time I was drinking and skiing my way across Europe in my second overseas assignment (this time in Germany). After four years in the military, I was pleasantly surprised to find my net worth had grown to $69K (Remember, this was the 1990s, and the stock market was producing some pretty spectacular returns). During this same tour, I made a rather embarrassing investing mistake by purchasing a Variable Universal Life (VUL) Insurance policy. I was already maxing out my IRA (which I converted to a ROTH IRA in 1999) and thought that I should shelter some more investments from taxes. I failed to do much research and ended up paying $150 a month for $200K worth of life insurance. Mixing insurance and investments was, and still remains, a terrible deal. It took me over a decade to come to my senses and cancel that policy (I now pay $47 a month for a 20-year $450K term life policy with USAA…in addition to SGLI). While in Germany, I met my future spouse and purchased an engagement ring by selling a substantial number of McDonalds shares…thereby allowing me to proclaim that her ring was paid for with Big Macs.
However, my bride to be hadn’t attended school on a full ride scholarship and had financed her undergrad and Master’s degree with student loans to the tune of $30K and a few hundred dollars in credit card debt. We moved back to the states and I sold my $500 car and assumed control of her old car (only 7 years old at the time…practically brand new as far as I was concerned) and purchased a new car for her: $26K…yes, love made me do some foolish things. All the newly acquired debt, plus a honeymoon for several thousand dollars (which we put on a credit card) took our new married net worth down to the range of about $8K. I still had the $69K in investments, but I learned that I really, really, hated debt. I wasn’t able to add much to our investments for a few years as we went into a frenzy trying to pay down the debt. After paying off the credit cards in the first few months, I began paying $750 a month towards student loans, $500 a month towards my first ever car payment, and we began funding a ROTH IRA for my wife…again, another $166.66 per month. Life was good and some months I was able to send in even more money towards the debts and we ended up paying off the student loan and the car in four years. We also added a child to the mix. I opened a 529 account for him while my wife was still in the hospital following delivery ($75 per month back then). Everything was great, and after the wife went back to work following her maternity leave for child number one, we were back on track building up net worth. We were up to around $100K when 11 Sep 2001 came around. I realized quickly that I would be deploying. I sat down and typed up a long list of account numbers, telephone numbers, and online passwords so that my wife could manage everything while I was deployed, or worse, in the event that I didn’t come back. Her eyes glazed over when I handed her the list, and it quickly became apparent that this plan wasn’t going to work. So, I bundled up all of our investment statements, drove to my wife’s home town, and opened a brokerage account by liquidating all the individual stocks and mutual funds. The front end sales fees were eye-wateringly large (5%…but they were lowered to 3.5% because we exceeded the $100K breakpoint). I wasn’t terribly happy with the investment choices (American Funds I believe), but I came back home with a single phone number and the name of our new broker for my wife to call in the event that she needed to manage things in my absence.
We drifted along steadily contributing to the children’s 529 plans (two of them by then) and adding to our ROTH IRAs…sadly, I didn’t always monitor the increases in annual contribution limits, so I failed to max out contributions some years. I would usually catch it a few years later and then up our contributions to the maximum…but my failure to monitor these changes is an indication of the lack of attention that I gave our accounts at the time. We were back down to a single income again and we contributed the remainder of our savings (not as much as we should have) into a taxable account with a series of high fee actively managed mutual funds recommended by the broker. I occasionally thought about opening a TSP account, but never got around to it…mostly due to laziness on my part and a desire not to complicate our financial situation. We spent a lot on travelling and general entertainment, not really paying attention to investments…net worth by 2003 was somewhere in the neighborhood of $130K. After yet another overseas assignment (this time for a military-funded Master’s Degree) we returned to the states and purchased a new minivan (I still hadn’t learned my lesson) to accommodate a third kid (and another 529 plan). That van was paid off in 3 years and we decided to buy our first house. We sold $60K worth of mutual funds in our taxable accounts in 2007 in order to put 20% down on a conventional 30-year mortgage at 5.875% (looking back, I should have opted for a 15-year mortgage). We bought our first house in May 2007…I suspect that the peak of the property bubble was June 2007. At any rate, our duty station was one of the “winners” under the latest round of BRAC, so the property market didn’t fare as badly there as it did in some other areas of the country. However, the 2008 recession severely depleted our ROTH IRAs and the remainder of our taxable accounts…not counting the equity in our house, were probably down around the $80K net worth range. We were 100% equities, 0% bonds. It appears that Charlie Munger (one half of the Berkshire Hathaway management team) was right when he said “accumulating the first $100,000 from a standing start, with no seed money, is the most difficult part of building wealth”.
When we finally received orders to move (once again overseas) I was in Afghanistan and I was trying to persuade my wife to sell the house. However, she is much wiser than me and talked me into renting it out. She had already lined up a tenant for $1800 a month and a property manager for 10% of the rental price…netting us $1620 per month. Our principal and interest payment on the mortgage was $1382 + $316 / month in taxes and insurance…so we were just about breaking even on a monthly basis. (The disparity is easier to accept if I choose to look at it as building $11 of equity per day in the house.) We were automatically paying an extra $100 a month towards the principal, and I would always try to send in a couple extra payments throughout the year. We weren’t upside down on the mortgage (thanks to the 20% down payment…and the additional principal only payments)…however, when I went to refinance the house in order to take advantage of the historically low interest rates…I found out that rates for “investment properties” were considerably higher than “owner occupied” rates. I didn’t take the plunge, so, that is still an area for improvement.
We arrived overseas in late 2010 (with yet another new minivan…I may never learn at this rate…however, this one was paid off in 2 years) and I began working with NATO. A NATO posting is a relaxing environment, and it allowed me an opportunity to survey my financial situation. During the process of updating my new mailing address with my bank, insurance, and broker…I decided to ask a few questions about fees and performance. Since my account balance had dropped back down below $100K I was back to paying 5% sales fee on each month’s contributions, and the broker couldn’t answer my questions about performance after fees. So, I began researching other options during the Winter of 2010-2011. That is when I stumbled across Bogleheads, Early Retirement.org, The-Military-Guide (only a few months old at that point), Andrew Hallam’s blog, etc. I began reading about the wisdom of passive investing with index funds and asset allocation to include a percentage of bonds. I was dismayed to find out that the information had been out there, but I had never bothered to go looking for it. I was so blindly confident in my own methods that I gave up a significant portion of my portfolio in fees over the years and had failed to appreciate the stabilizing influence of bonds. I also realized that I was going to have to massively increase our savings rate if I hoped to successfully retire and not suffer a significant decrease in lifestyle.
PART II: The Current Situation
Don’t misinterpret my last sentence. I am much better prepared for retirement than most of my civilian friends, but I am appalled that despite a steady stream of saving for 29 years, I still would not have enough to fund an adequate retirement if it weren’t for a military pension.
After several months of reading everything I could get my hands on, I decided that the best bet was a diversified portfolio of low-cost index funds with Vanguard. The wisdom of choosing index funds is perhaps best explained by the experts as laid out in Andrew Hallam’s blog, or you can check out the grand daddy of all the index fund advocates and listen to the Bogleheads as they champion a simple low cost index fund approach. I also remembered an earlier lesson where my wife expressed absolutely no interest in managing our financial portfolio. So, with the realization that if I die tomorrow, the fund / asset allocations would never be adjusted unless I put it on autopilot, I opted to put our investments into target retirement funds for the ROTH IRAs, age based 529 plans for the kids, and a Life Strategy fund for our taxable account. This plan also keeps me from meddling with the allocation as I am still tempted to adjust our equity / bond ratio to be more aggressive (by selecting a later retirement date fund). Our current ratio (based on the values of the underlying funds) is roughly: 70% stocks / 20% Bonds / 10% cash (emergency fund). I’m also mindful of the fact that a military pension could be considered as being roughly equivalent to an annuity or the bond portion of a portfolio and that interest rates have nowhere to go but up. However, I don’t even attempt to guess when rates will change, or what will happen next. I have seen repeated studies that show women are better investors than men precisely because they accept a larger portion of bonds in their portfolios and they don’t constantly buy or sell in an attempt to time the market. I’m trying to be wise and learn from that insight.
So, what does the portfolio look like now?
Vanguard Target Retirement 2035 Fund (VTTHX) for my ROTH IRA and the 2040 version (VFORX) for my wife’s ROTH IRA. We contribute $416.66 to both funds, each and every month via an automatic draft from our checking account. Automating this monthly contribution was the single best decision we made with regards to staying on a consistent path of savings. I haven’t missed a monthly contribution to my IRA and subsequent ROTH IRA since starting it in 1994…and my wife hasn’t missed a contribution since we started hers in 1999. The current combined value of these two accounts is around $130K (but this obviously fluctuates daily). As a side note, we rolled $6K into my wife’s ROTH IRA from an old 403(b) teacher’s retirement plan that she accumulated back in her working days.
Our joint taxable account is in the Vanguard Life Strategy Moderate Growth Fund (VSMGX) with approximately $21K. We don’t make monthly contributions to this fund, but we do occasionally add to it (such as income tax refunds). This taxable joint account was where we withdrew our $60K for a down payment on a house back in 2007.
All three kids have Vanguard Moderate Age-Based Option 529 plans. These plans also have an automatic monthly contribution (currently $125 per child…up from the original $75 we used to contribute) and have respective balances of: $14K (for our 12 year old), $12K (for our 10 year old) and ($8K for our 8 year old). I am growing increasingly concerned that these will not cover much in the way of education expenses when they start college in 2019, 2021, and 2023 respectively. However, I have already transferred my post-911 GI Bill benefits to all three children. My wife and I both have graduate degrees and don’t anticipate pursuing doctorates at this stage of life. However, I still added my wife to the GI Bill benefits in the off chance that all 3 children manage to go to school on scholarships. My intention is to try to fund 4 years tuition costs at an in-state public university. Anything above that (private school costs, a master’s degree, etc.) will be on them to fund.
The ROTH TSP option just opened for the military in October 2012. So, we have begun contributing to that as well (Currently $417 per month)…but the balance for that is obviously pretty low since we just started. Incidentally, the money for this contribution was freed up once we paid off our minivan. Once again, I opted for simplicity and selected the Lifecycle 2040 fund in order to automate the gradual shift from equities to bonds as we age.
[Nords note: the figures that follow are documented in this Excel spreadsheet. (Clicking on that link will download a file to open in your spreadsheet program.) The numbers on the spreadsheet seem like a pile of money in 2012 dollars, but those future dollars include projected annual pay raises. Future expenses will also rise with inflation. Again, if you decide to use this for your own calculations, please contact me to discuss the assumptions.]
So, discounting the 529 plans (since they will be exhausted by 2027) we are sitting on approximately $150K in stocks and bonds, and about $17K in cash. With the two ROTH IRAS, plus the new ROTH TSP, we contribute a minimum of $15K per year. So, at that rate of savings, and at a 5% growth rate…we are on track to have $1 million by the time I turn 65 years old. Yes, I realize that we could argue all day over my selection of a 5% growth rate…however, I had to select something, and I opted on the conservative side of historical returns. Also, the yearly ROTH IRA contribution limits are set to increase in the future (see, I have learned to pay attention to these things now), and we hope to also be able to increase our ROTH TSP contribution.
Part III: The future
Using the figures above, and with the standard 4% withdrawal rate (yes, this is another controversial figure that we could argue over, but it is the standard figure used to have a decent chance of having your portfolio last 30 years…it is from the famous “Trinity Study”) this throws off a starting yearly income of $40K at 65 years old. While you can potentially adjust this amount up (to account for inflation) or down (to account for poor investment returns) each year, it is a good baseline number to work with. So, could I retire on that amount? I could, but something tells me that the wife wouldn’t like living on less than 40% of what we are currently spending each year. We spent a shocking $119K in 2012, so we have some cost cutting to do if we intend to have a chance at a comfortable retirement. I’d better re-read some of the Mr. Money Mustache blog posts to figure out what I’m doing so wrong (however, a significant portion of that “spending” is actually mortgage pre-payment, and the accelerated car payments that we made in order to pay off the minivan this year and take advantage of the ROTH TSP). We use Mint.com to track all of our income, spending, and investments. It has made a huge difference in our ability to accurately assess where we are wasting money…$19K on food & dining in 2012…WTF?
However, the scene isn’t as dire as I am portraying. I am eligible to retire in another year, and the “High-3” 20 year retirement for an O-5 (after subtracting 6.5% for the Survivor’s Benefit Plan, and the TRICARE Insurance Premium) works out to $44,900 per year. Waiting until year 24 to retire gets us $58,558 per year, and waiting until the maximum 28 years (for an O-5) means $69,797 per year…not too shabby. Please note that all these figures are pre-tax.
So, when can I join Nords in retirement? Well, I honestly love my current job in the military. I’ll continue to stay in as long as it’s fun. And, once I retire, I don’t have to swing for the fences in the job market since I’ll have a pension…and hopefully a paid off rental property generating $1620 a month…so I’ll take another job that I enjoy…most likely in a field utilizing the Master’s degree that the military paid for. My youngest should finish college when I am 56 (unless she is a slow learner like me). I figure on a few years to rebuild the finances, and I suspect that I can quit for good at age 58. If I wait another year and a half, I can start withdrawing from the various ROTH IRAs and ROTH TSPs at 59.5 without penalty. My wife can draw off her own ROTH IRA two years later, and claim Social Security off her earnings at 62 (a paltry $537 per month according to the Social Security Website). Given her family’s propensity towards longevity, my plan is to wait to claim my own Social Security until age 70 ($2,699 per month according to estimates if I continue to earn a similar salary), at which point my wife can claim half my earnings ($1,349.50 per month) as a spousal benefit. I’d also like to ensure that I have 35 years of earnings for Social Security calculations in order to ensure no zeros are used in the computations…so that takes me out to the year 2029, when I will be 58 years old. So, the timeline still holds for a retirement around that time period…if we choose.
Part IV: The lessons
So, what can you (and I) learn from this posting? Well, there are some obvious pitfalls to avoid (a lack of diversification, failure to take brokerage fees into account, and mixing insurance with investments) and some areas of success to emulate (utilizing the ROTH IRA to grow portfolios tax-free, automating investment contributions, and focusing on low expense investment options). However, the biggest lesson that I can pass along is to educate yourself on personal finance issues. I could kick myself for waiting until almost age 40 to learn these lessons and I’d encourage you to start your financial education much earlier. If you are short on time, or lack the desire, then at least arm yourself with the best, concise article I’ve ever read on the topic. Check out Darrow Kirkpatrick’s blog: “Can I retire yet?” and get a copy of his free 16-page eBook. He doesn’t spam you, and he doesn’t try to sell you anything. He is simply an engineer (and also a military brat) who figured out how to retire early, and he started blogging about it. If you have a little more time and interest, then I really recommend that you check out Andrew Hallam’s book “Millionaire Teacher”. Mr. Hallam teaches at an International High School in Singapore and does an excellent job of explaining the basics of passive investing in low-cost index funds. I am of course also a fan of Mr. Doug Nordman’s own book and website, but you are probably already familiar with those if you are reading this article. Lastly, I’ll recommend any of the excellent books by Mike Piper of Oblivious Investor.
So, what did I learn from this process? At first, I was reluctant to write a guest posting, but with the encouragement of Mr. Doug Nordman and my wife, I opted to sit down and calculate how the future might look. In order to research this, I was forced to figure out my total lifetime income, and see where I had wasted precious years of potential investment contributions and returns simply due to ignorance. I saw that while I had previously thought I was doing a sufficient job of saving, it became apparent that everything I had done up until 2010 was just a shot in the dark. I was uninformed and I realized that sharing this story could help others start to focus on their futures at an earlier age. I know the process has been illuminating for me, and I suggest that others take the time to work through some calculations to see what kind of lifestyle they are capable of supporting in retirement. So, after all the calculations, what can I realistically hope to achieve (without accounting for taxes or inflation)?
The early retirement scenario (retiring after 20 years in the military and working as a civilian until age 59.5 when I can tap into the ROTH IRA, with spouse and I claiming social security at 62):
$32,163 (Representing 4% per year from our investment accounts)
$44,900 (Annual military pension for an O-5 with 20 years)
$17,928 (Annual social security if I claim at age 62)
$6,444 (Spouse’s annual social security benefit if she claims at 62)
$0 (Rental income, assuming that we would still have a mortgage)
$101,435 (Total annual income)
It is worth noting that this is below our 2012 spending. However, we would be empty nesters by then, so it should still represent a sustainable lifestyle.
Now, what if I decided that I was going to attempt to shoot for the maximum and retire later, what could I achieve?
The late retirement scenario (again, without accounting for taxes or inflation), retiring after 28 years in the military and working as a civilian until age 70 when I would finally claim social security is:
$60,314 (Representing 4% per year from our investment accounts)
$69,797 (Annual military pension for an O-5 with 28 years)
$32,388 (Annual social security if I wait until age 70 to claim)
$16,194 (Annual spousal social security benefit: 50% of above)
$19,440 (Annual rental income)
$198,133 (Total annual income)
Not too bad for a guy that didn’t know what he was doing when he started investing…and didn’t know how much he would have for retirement until he wrote this article.
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Reminder: This is a guest post. Please be polite, or the comments moderator will kick in. Remember that the writer reads the Early-Retirement.org, Bogleheads.org, and MrMoneyMustache.com discussion boards– and you should too!
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