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).
We’ll wrap this up in part 2.