Retirement Basics
Show Notes
Good, simple options for retirement investing
More information on retirement and financial independence
- Financial Independence / Retire Early subreddit FAQ
- The Millionaire Next Door: The Surprising Secrets of America's Wealthy by Thomas J. Stanley and William D. Danko (amazon, goodreads)
- I Will Teach You To Be Rich by Ramit Sethi (amazon, goodreads)
Music
- Intro music: Vlog Music Cafe Type Hip-Hop Instrumental Chill Lo-Fi Beat by Oliwia Orłowska
- Outro music: Game Over [Super Mario World Lofi/hiphop remix] by Neighborhood Vandal
Transcript
Ulysse: Hey, this is the Growth Podcast with your hosts, Ben and Brendon. This episode, we'll be talking about planning for retirement, or how to use the stock market for greater good.
Ulysse: Yeah, I wanted to talk to you about financial planning and retirement planning. I know that while you are technically a financial advisor, nothing you say can be counted against you in a court of law as a financial advisor. But you're probably the most knowledgeable person I know about finance and retirement and the stock market, so I wanted to pick your brain about that kind of stuff.
Brendon: Sounds good, Ben.
Ulysse: Some of my friends, or actually a lot of my friends, probably make between $40k to $60k to $80k a year in the US. They have some savings, sure, but they don't know how to plan for retirement. They're not quite sure how to ensure they'll have enough money when they reach their retirement age, whatever that is now. 105, I don't know. So what advice would you give someone who is making around that amount of money and wants to know more about retirement planning?
Brendon: Yeah, so basically all of the advice that's out there is around getting yourself a reliable annual stream of income after you enter retirement or after you decide to stop working. And that can be earlier in life too, if somebody is interested in transitioning away from their primary career and pursuing something else that they would benefit from having a higher degree of financial independence in. Income streams usually come from people saving up from a very young age, investing that money, and then having a pretty large pool of money to draw from once they reach retirement.
Brendon: It's important to note that this is the most popular approach because it's the most doable. Just set aside a certain amount of money every year. Investments usually increase at an annual rate of, let's just say, between 5% to 10% a year. And so that means that annual saving combined with compounding interest, by the time you reach retirement age you have a very nice nest egg you're sitting on top of.
Ulysse: Nice.
Brendon: And of course that's not the only way to get a reliable stream of income in retirement. Instead of just saving up a large pool of money and then drawing a certain percentage out when you reach retirement, you can also do other things like start a small business, which can also generate reliable income. You can invest in rental property and that generates income every month. You could even do really creative things, like if you're a artist or something, or you own the rights to some intellectual property or something, then that can definitely generate you an income stream later in life.
Brendon: But by far, the most popular way to save for retirement is through saving and investing because anyone can get started with doing that.
Ulysse: Cool. So let's talk about the first thing you mentioned, having some sum of money that you can pull from every year. How would I go about making that happen?
Brendon: Yeah, so actually anyone can save up enough money to have a comfortable retirement. And the real secret is you get started early with saving a significant amount of the income you're earning every year. I think a mistake that's especially common among younger people, and also people in certain countries like the United States, is just having an overly low savings rate. People in some countries save a very high percentage of the income they earn every year, but in the US that's actually pretty low. A lot of Americans actually do not even have any retirement savings.
Brendon: While it is true that earlier in your career you might be making a little bit less money, it's still very important to be saving a significant fraction of that money. And that reason is because of investing and compound interest. If you don't invest, then it might make sense to wait for your salary to just double over like one or two decades, and then start saving a fraction of your money. Because earlier in life you were comfortable living on a lower salary, so later in life you can set aside more money just for retirement savings. And this would work brilliantly except for the fact that, as some listeners may be familiar with, the concept of compounding interest, you are earning interest on interest that you've previously earned.
Brendon: What that basically means is, when you're earning a steady rate of interest every single year, your investments are growing at an exponential rate. Which means that the more time passes by, the faster your money multiplies. So it might take a long time for your money to initially double, but then it might take only like half the time for it to double again. And so that's why it's very important to get started with investing as early as possible when you're very young. So I would say, the key for people is they need to start saving early and then they need to start investing that money as they are saving it. You can't just put that money in a bank account. That won't be very helpful.
Ulysse: I know savings accounts don't have great rate of returns. They only give you like 1% to 2%, if that, per year in annual compound interest, right?
Brendon: Yep.
Ulysse: Where should I be putting most of my money?
Brendon: Yeah, so the real problem with savings accounts is, while it is true that some of them are paying a return, for example, in recent decades that has been maybe between 0% to 2%, you're not necessarily earning money because of inflation.
Ulysse: Oh, okay.
Brendon: So even as your money accrues in a savings account, the value of each dollar is decreasing. So at the end of the day, your spending power might actually not be changing. So I view a statements account as just sort of a bare minimum thing, something someone should be doing to retain their money's purchasing power. But I definitely would not say a savings account is a good way to save for retirement. It's only suitable for very short term goals. Where do you actually put the money? How do you actually get that estimated annual rate of return?
Brendon: And the two main instruments that people use when investing are stocks and bonds, simply because they are extremely accessible for typical investors to get into and they deliver decent rates of return, and have delivered decent rates of return for decades or even centuries.
Ulysse: Okay, so stocks and bonds might be something that can produce some compound interest every year. What exactly are stocks and bonds?
Brendon: There are only two ways companies can actually raise money for themselves. Method number one is by issuing stock. And a stock is just a share of ownership in a company. So for example, if you own all the stocks in the company and one day the company goes out of business, you will just end up owning all the assets the company owned. So if the company had $100 in its bank account and it had no debt, and if the company went under and you owned all the stock in a company, then you would get that $100.
Ulysse: Nice. I love bankruptcy.
Brendon: Right. So yeah, a stock is just a fractional share of ownership in a company. You're entitled to the company's assets and a share of its earnings after all debts have been paid off. So that's one way a company can raise money. And the other way a company can raise money is by borrowing money. And of course, a company can raise money by loaning money from a bank, but it can also raise money by issuing things called bonds. And a bond is just basically a loan to a company that anyone can actually buy.
Brendon: So of course, in exchange for loaning your money to the company, the company will pay you a certain percentage rate of interest every single year. And so that's basically two ways a company can raise money. It can issue shares of ownership, or it can borrow money. And that's how you as an investor can make money, either by buying shares of ownership in a company or by loaning money to companies. It is also important to note that there's also other types of bonds. For example, the US government allows people to buy US government bonds. And so that basically means you're just loaning money to the US government. So there are a lot of different types of bonds, but only one type of stock.
Ulysse: So these are sort of the fundamental units, right? But I imagine when you're actually interacting with the stock market, you're probably investing in pools of bonds or pools of stocks or funds, right? What if you or I wanted to actually go about buying some stocks or bonds today. What would I be buying? How would I buy it?
Brendon: Yeah. So the first step in actually investing in things like stocks and bonds is to open up a brokerage account. And for listeners who aren't familiar, a brokerage account is very similar to a bank account. You can send money in, you can move money out. Except, instead of just holding money in a brokerage account, a brokerage account also enables you to move that money into investments and away from cash. So into things like stocks and bonds.
Brendon: So it is true that from a brokerage account, you can directly buy stocks and bonds, but for most investors, it's advised that you use an investment fund instead. An investment fund is basically a legal entity that pools money from a lot of different investors and invests that entire pool of money on the investors' behalf. So for example, an investment fund can pool money from millions of people and buy 500 big stocks in the United States. And that is called the S&P 500 Stock Index, which some listeners may be familiar with hearing on the radio or something.
Ulysse: Why would you want to invest in a pool or some fund instead of just buying individual stocks or bonds?
Brendon: Yeah, so first of all, while it's possible that investing in a single stock can be very beneficial, it's also very risky. For example, what if you love Carnival Cruises, and so you decided to move all your money into Carnival's stock? But then coronavirus hits and then the value of Carnival's stock drops to like near zero.
Ulysse: You're stuck on a cruise ship for seven weeks extra.
Brendon: Right, right. So the issue there is, if you bought Carnival stock you've basically lost all of your money. So a really common thing that's advised when you invest is to diversify, to spread your money out among a bunch of different investments. For example, a bunch of different stocks, and also a bunch of different types of assets like stocks, bonds, real estate, et cetera. One of the key reasons for this is spreading out that risk so that you're less likely to suffer a large drops in your investment portfolio. It also can help improve investment returns when you diversify.
Brendon: For example, if your portfolio drops 50%, you actually need to grow your portfolio another 100% in order to just make back the money that you've lost. So losses are actually pretty problematic when you're investing. When you spread your money out among a bunch of different investments, this typically reduces the total drop that can be expected when you are investing, and that actually has the effect of potentially significantly improving your investment returns in the long run.
Ulysse: So when you invest in multiple stocks and multiple bonds, you're betting on the fact that they will all go up over time, or most of them will go up over time, and that you will make a return, instead of one individual one going up a ton and making a huge move for you?
Brendon: Yes, that's correct. It's very important to note that, for example, stocks and bonds have been around for centuries. And basically, just due to the nature of these investments, stocks and bonds as a whole have just tended to move up in value. For example, the reason why stocks move up in value is that the companies that you're owning are generally becoming bigger. For example, Apple started out as a small computer company and it's now very large. Same with other major companies that we're familiar with. Companies typically grow, and they typically grow at a faster rate than just doing nothing. So as long as you're investing in companies that are growing, you would expect your money to increase faster than just holding it inside a checking or savings account.
Brendon: With bonds, borrowing money isn't free. Companies need to pay you some interest in exchange for borrowing your money. And so that's why your money increases when you're buying bonds. And yes, when you spread your money out among a bunch of different stocks or a bunch of different bonds, your portfolio is much more influenced by the movement of the entire stock and the entire bond market, rather than individual stocks and bonds.
Ulysse: So in terms of stock and bond funds, which ones do you recommend?
Brendon: I generally recommend buying total market stock and bond funds for someone that is just getting started with jumping into investing. Because sometimes it can be a little bit confusing for people to think, “Hey, should I be moving more money into a small cap fund? A mid cap fund?” Some of these people may not know the difference between different funds. A total market stock market fund would capture a large fraction of the US stocks that are currently in existence, and it's the same with a total market bond fund. So starting off with a total market fund is a good way to get started.
Brendon: And a specific company that I do recommend is funds that are provided by Vanguard, for the simple reason that Vanguard is basically a customer owned company, so their incentive is to actually keep the fees of their funds as low as possible. And that's something that a lot of other companies just cannot provide by nature, by the fact that they're for-profit companies.
Ulysse: So I can move my money into a total stock market fund or a total bond market fund, right? How do I know how much to distribute where?
Brendon: Yeah, so there's a very significant difference in risk between stocks and bonds. For example, in the 2008 Great Recession, the stock market fell around 50% from its highest point to its lowest point, and the bond market only fell 5% from its highest point to its lowest point. And that's basically a 10X difference in risk. The stock market generally grows at a significantly higher rate every year compared to the bond market. The stock market has actually appreciated around 10% on average over the past decades, and if you adjust for inflation, that's about 7% per year. And that's a pretty good rate of return. And the return for bonds is considerably lower by around half.
Brendon: So in terms of whether to keep your money in stocks and bonds, one thing that investors should consider is what amount of risk they're comfortable with, but it's also important to consider your investment timeframe. For example, people who are very young, like people in their 20s, people in their 30s, even 40s, should keep a very high proportion of their investments in stocks, at least for retirement. The idea is you're not going to touch the retirement money for many years, and so it shouldn't matter whether or not the market is moving down a lot or moving up a lot. You're kind of just letting that money sit there and appreciate over the long haul without making considerable adjustments to it.
Brendon: And so, if you just leave your money in stocks and don't pay too much attention to the fluctuations, you will earn a lot more money compared to if you had all that money in bonds.
Ulysse: Got it.
Brendon: So if you're starting out early in your life, yeah, 80% to 100% is fairly acceptable. As you approach retirement, you might want to approach more like 50% stocks and 50% bonds, and maybe like 30% stocks and 70% bonds. A popular rule of thumb for this sort of thing is 100 minus your age. So for example, if you're 20, then you would do a 100 minus 20, and you would put 80% of your investments into stocks. And if you are approaching retirement, let's say you are 60, then 100 minus 60 would be 40. So only 40% of your portfolio should be in stocks.
Brendon: So this is just a very, very approximate rule. I don't actually recommend following this particular approach, but I can just give you an idea of how you might want to adjust your investments over time that actually corresponds fairly well to what people actually do in practice.
Ulysse: I could imagine that even what we said today might be a little too complicated for some people. What's a first step I should take if I want to start investing in retirement?
Brendon: Yeah, so I'll go from sort of easiest to hardest in terms of people wanting to get started with investing. So the absolute easiest way to get started with investing is to use a robo-adviser, and that's a name that means an online service that walks you through getting started with investing. For example, Betterment and Wealthfront are some of the largest robo-advisors in the United States. And this phenomenon is actually becoming very common around the world as well. One of the great things about robo-advisors is that they will, for example, walk you through the different types of investment accounts that you might want, like an IRA, a taxable brokerage account, stuff that people may not be familiar with. And they will also automatically invest your money in a mix of funds that is appropriate.
Ulysse: Got it.
Brendon: So this is the absolute easiest way to get started with investing. And I think this can be a good jumping off point because you can see what types of accounts they are opening up for you, you can sort of see what funds your money is being held in inside the account the rob-advisor is managing for you, and then you can learn about what the robo-advisor is doing so that you can do it yourself.
Brendon: Just a key downside of this approach is that robo-advisors do charge a fee. For example, I think the top robo-advisors in the US are currently charging around 0.25% per year, which is a lot cheaper than a traditional financial advisor which might be charging over 1% a year. But it still does eat into your returns in the long run.
Brendon: I would say that a more affordable and nearly as easy way to get started, is to invest in a target date retirement fund. It's an investment fund that has a certain retirement year that's associated with it. For example, a 2060 target date retirement fund that will help you invest like you are planning on retiring around the year 2060. This is a really good approach because typically target date funds will charge fairly low fees. For example, a Vanguard target date fund actually doesn't charge you any fee. The only fees that it charges you are the fees that you would be charged if you were buying the underlying funds themselves, which that's what you'd be doing anyways if you were investing on your own.
Ulysse: Got it.
Brendon: So the cheapest way to get started investing on your own, and the most simplest, is to open up a brokerage account and just move all your money into a target date fund that has an associated year that's close enough to the year you might be retiring.
Ulysse: Thanks for listening. If you're new to this, don't worry. There are a lot of great resources online, and the most important thing is that you just get started. You don't have to be a financial expert to invest in a retirement fund. Brendon and I have included a few links to help you in the show notes. The beautiful intro music to this episode was created by Oliwia Orłowska. This relaxing melody is by Neighborhood Vandal. Links to both of these songs can be found in the show notes.
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